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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 

**x****                QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the quarterly period ended September 30, 2010**

 

**OR**

** **

**o****                   TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the transition period from           to          **

 

**COMMISSION FILE NUMBER 000-29661**

 

**UTSTARCOM, INC.**

(Exact name of registrant as specified in its charter)

 

| **DELAWARE**                                  | ** ** | **52-1782500**                       |
|-----------------------------------------------|------------|--------------------------------------|
| (State of Incorporation)                      |       | (I.R.S. Employer Identification No.) |
|                                          |       |                                 |
| **20F, TOWER E1, THE TOWERS, ORIENTAL PLAZA** | ** ** | ** **                           |
| **No. 1 EAST CHANG AN AVENUE**           | ** ** | ** **                           |
| **DONG CHENG DISTRICT BEIJING, P.R. CHINA**   | ** ** | **100738**                           |
| (Address of principal executive offices)      |       | (zip code)                           |

 

Registrant’s telephonenumber, including area code: +**86(10)8520-5588**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes x No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). Yes o No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (check one):

 

| Large accelerated filer o                |   | Accelerated filer x         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer o                  |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                             |

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o No x

 

Asof November 1, 2010 there were 150,686,033 shares of the registrant’scommon stock outstanding, par value $0.00125.

 

 

 

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**TABLE OFCONTENTS**

 
| PART I—FINANCIAL INFORMATION                                                                  | 3  |
|---------------------------------------------------------------------------------------------------------|----|
| ITEM  1—CONDENSED  CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)                                   | 3  |
| ITEM 2—MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 25 |
| ITEM 3—QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                 | 42 |
| ITEM 4—CONTROLS AND  PROCEDURES                                                                    | 44 |
| PART II—OTHER INFORMATION                                                                     | 46 |
| ITEM 1—LEGAL PROCEEDINGS                                                                           | 46 |
| ITEM 1A—RISK FACTORS                                                                               | 46 |
| ITEM 2—UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                | 46 |
| ITEM 3—DEFAULTS  UPON SENIOR SECURITIES                                                            | 47 |
| ITEM 4—REMOVED AND RESERVED                                                                        | 47 |
| ITEM 5—OTHER INFORMATION                                                                           | 47 |
| ITEM  6—EXHIBITS                                                                                   | 47 |
| SIGNATURES                                                                                              | 49 |

 

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**PART I—FINANCIALINFORMATION**

 

**ITEM 1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

 
| ** **                                                                                                                                                                           | ** ** | **September 30,**                                   | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **2010**                                                 | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                                           | ** ** | **(In thousands, except par value)** | ** ** |
| **ASSETS**                                                                                                                                                                           |       |                                                     |       |                  |       |
| Current assets:                                                                                                                                                                      |       |                                                     |       |                  |       |
| Cash and cash equivalents                                                                                                                                                            |       | $                                                        | 337,026    |                  | $          | 265,843 |   |
| Short-term investments                                                                                                                                                               |       | 972                                                      |       | 1,038                 |       |
| Accounts receivable, net of allowances for  doubtful accounts of $32,409 and $26,065, respectively                                                                                   |       | 41,632                                                   |       | 42,346                |       |
| Notes receivable                                                                                                                                                                     |       | 461                                                      |       | 1,427                 |       |
| Inventories                                                                                                                                                                          |       | 51,857                                                   |       | 72,300                |       |
| Deferred costs                                                                                                                                                                       |       | 122,540                                                  |       | 130,453               |       |
| Prepaids and other current assets                                                                                                                                                    |       | 47,286                                                   |       | 47,906                |       |
| Short-term restricted cash                                                                                                                                                           |       | 22,444                                                   |       | 26,448                |       |
| Total current assets                                                                                                                                                                 |       | 624,218                                                  |       | 587,761               |       |
| Property, plant and equipment, net                                                                                                                                                   |       | 4,810                                                    |       | 130,612               |       |
| Long-term investments                                                                                                                                                                |       | 9,129                                                    |       | 8,402                 |       |
| Long-term deferred costs                                                                                                                                                             |       | 152,562                                                  |       | 184,978               |       |
| Long-term deferred tax assets                                                                                                                                                        |       | 5,601                                                    |       | 4,822                 |       |
| Other long-term assets                                                                                                                                                               |       | 14,664                                                   |       | 12,536                |       |
| Total assets                                                                                                                                                                         |       | $                                                        | 810,984    |                  | $          | 929,111 |   |
| **LIABILITIES  AND EQUITY**                                                                                                                                                          |       |                                                     |       |                  |       |
|  Current  liabilities:                                                                                                                                                          |       |                                                     |       |                  |       |
| Accounts payable                                                                                                                                                                     |       | $                                                        | 29,724     |                  | $          | 54,115 |   |
| Income taxes payable                                                                                                                                                                 |       | —                                                   |       | 1,130                 |       |
| Customer advances                                                                                                                                                                    |       | 86,450                                                   |       | 120,364               |       |
| Deferred revenue                                                                                                                                                                     |       | 181,785                                                  |       | 170,777               |       |
| Deferred tax liabilities                                                                                                                                                             |       | 3,890                                                    |       | 3,890                 |       |
| Other current liabilities                                                                                                                                                            |       | 83,360                                                   |       | 142,894               |       |
| Total current liabilities                                                                                                                                                            |       | 385,209                                                  |       | 493,170               |       |
| Long-term deferred revenue                                                                                                                                                           |       | 144,877                                                  |       | 160,932               |       |
| Other long-term liabilities                                                                                                                                                          |       | 27,590                                                   |       | 18,858                |       |
| Total liabilities                                                                                                                                                                    |       | 557,676                                                  |       | 672,960               |       |
| Commitments and contingencies (Note 10)                                                                                                                                         |       |                                                     |       |                  |       |
| UTStarcom, Inc. stockholders’ equity:                                                                                                                                      |       |                                                     |       |                  |       |
| Common stock: $0.00125 par value; 750,000  authorized shares; 150,686 and 130,095 shares issued and outstanding at  September 30, 2010 and December 31, 2009, respectively |       | 176                                                      |       | 153                   |       |
| Additional paid-in capital                                                                                                                                                           |       | 1,292,176                                                |       | 1,251,532             |       |
| Accumulated deficit                                                                                                                                                                  |       | (1,109,274                                               | )          | (1,067,174            | )          |
| Accumulated other comprehensive income                                                                                                                                               |       | 69,444                                                   |       | 70,848                |       |
| Total UTStarcom, Inc. stockholders’ equity                                                                                                                                 |       | 252,522                                                  |       | 255,359               |       |
| Noncontrolling interests                                                                                                                                                             |       | 786                                                      |       | 792                   |       |
| Total equity                                                                                                                                                                         |       | 253,308                                                  |       | 256,151               |       |
| Total liabilities and equity                                                                                                                                                         |       | $                                                        | 810,984    |                  | $          | 929,111 |   |

 

See accompanying notes to the condensed consolidated financialstatements.

 

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**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**

 
| ** **                                                                     | ** ** | **Three months ended September 30,**           | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2010**                                                           | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                     | ** ** | **(in thousands, except per share data)** | ** ** |
| Net sales                                                                      |       |                                                               |       |                                                    |       |   |   |   |   |
| Products                                                                       |       | $                                                                  | 52,041     |                                                    | $          | 53,920 |   | $ | 183,836 |   | $ | 225,167 |   |
| Services                                                                       |       | 9,353                                                              |       | 16,584                                                  |       | 31,570 |   | 44,840 |   |
|                                                                           |       | 61,394                                                             |       | 70,504                                                  |       | 215,406 |   | 270,007 |   |
| Cost of net sales                                                              |       |                                                               |       |                                                    |       |   |   |   |   |
| Products                                                                       |       | 43,065                                                             |       | 36,994                                                  |       | 132,854 |   | 211,296 |   |
| Services                                                                       |       | 6,236                                                              |       | 9,321                                                   |       | 20,378 |   | 28,708 |   |
| Gross profit                                                                   |       | 12,093                                                             |       | 24,189                                                  |       | 62,174 |   | 30,003 |   |
| *See Note 17 for net sales to  related party and associated cost of net sales* |       |                                                               |       |                                                    |       |   |   |   |   |
| Operating expenses:                                                            |       |                                                               |       |                                                    |       |   |   |   |   |
| Selling, general and administrative                                            |       | 24,530                                                             |       | 33,139                                                  |       | 75,882 |   | 114,290 |   |
| Research and development                                                       |       | 9,922                                                              |       | 14,246                                                  |       | 29,023 |   | 51,983 |   |
| Restructuring                                                                  |       | 2,336                                                              |       | 8,909                                                   |       | 9,627 |   | 41,485 |   |
| Net (gain) loss on divestitures                                                |       | (1,436                                                             | )          | 1,689                                                   |       | (5,244 | ) | 332 |   |
| Total net operating expenses                                                   |       | 35,352                                                             |       | 57,983                                                  |       | 109,288 |   | 208,090 |   |
|                                                                           |       |                                                               |       |                                                    |       |   |   |   |   |
| Operating loss                                                                 |       | (23,259                                                            | )          | (33,794                                                 | )          | (47,114 | ) | (178,087 | ) |
|                                                                           |       |                                                               |       |                                                    |       |   |   |   |   |
| Interest income                                                                |       | 594                                                                |       | 462                                                     |       | 1,392 |   | 1,810 |   |
| Interest expense                                                               |       | (70                                                                | )          | (24                                                     | )          | (208 | ) | (544 | ) |
| Other income (expense), net                                                    |       | 6,967                                                              |       | (1,556                                                  | )          | 7,067 |   | (3,341 | ) |
|                                                                           |       |                                                               |       |                                                    |       |   |   |   |   |
| Loss before income taxes                                                       |       | (15,768                                                            | )          | (34,912                                                 | )          | (38,863 | ) | (180,162 | ) |
| Income tax benefit (expense)                                                   |       | (1,400                                                             | )          | 317                                                     |       | (3,243 | ) | (6,166 | ) |
| Net loss                                                                       |       | (17,168                                                            | )          | (34,595                                                 | )          | (42,106 | ) | (186,328 | ) |
| Net (gain) loss attributable to noncontolling  interests                       |       | (4                                                                 | )          | 15                                                      |       | 6 |   | 32 |   |
| Net loss attributable to UTStarcom, Inc.                                  |       | $                                                                  | (17,172    | )                                                       | $          | (34,580 | ) | $ | (42,100 | ) | $ | (186,296 | ) |
|                                                                           |       |                                                               |       |                                                    |       |   |   |   |   |
| Net loss per share attributable to  UTStarcom, Inc.- Basic and Diluted    |       | $                                                                  | (0.13      | )                                                       | $          | (0.27 | ) | $ | (0.32 | ) | $ | (1.47 | ) |
|                                                                           |       |                                                               |       |                                                    |       |   |   |   |   |
| Weighted average shares used in per-share  calculation - Basic and Diluted     |       | 135,550                                                            |       | 127,875                                                 |       | 131,781 |   | 126,930 |   |

 

Seeaccompanying notes to the condensed consolidated financial statements.

 

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**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**

 
| ** **                                                                         | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                                                                         | ** ** | **(In thousands)**                                 | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                              |       |                                                    |       |   |   |
| Net loss                                                                           |       | $                                                       | (42,106    | ) | $ | (186,328 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities:       |       |                                                    |       |   |   |
| Depreciation and amortization                                                      |       | 4,166                                                   |       | 10,177 |   |
| Amortization of deferred gain on sale-leaseback                                    |       | (429                                                    | )          | — |   |
| Provision for (recovery of) doubtful accounts                                      |       | 6,012                                                   |       | (3,659 | ) |
| Other-than-temporary impairment of equity  investment                              |       | —                                                  |       | 5,517 |   |
| Stock-based compensation expense                                                   |       | 6,131                                                   |       | 9,434 |   |
| Net (gain) loss on divestitures                                                    |       | (5,244                                                  | )          | 332 |   |
| Gain on settlement of an investment interest                                       |       | (481                                                    | )          | — |   |
| Deferred income taxes                                                              |       | (567                                                    | )          | 2,341 |   |
| Other                                                                              |       | 366                                                     |       | (634 | ) |
| Changes in operating assets and liabilities:                                       |       |                                                    |       |   |   |
| Accounts receivable                                                                |       | (8,685                                                  | )          | 108,947 |   |
| Inventories and deferred costs                                                     |       | 67,046                                                  |       | 40,512 |   |
| Other assets                                                                       |       | 3,318                                                   |       | 62,380 |   |
| Accounts payable                                                                   |       | (32,445                                                 | )          | (132,005 | ) |
| Income taxes payable                                                               |       | 192                                                     |       | 2,200 |   |
| Customer advances                                                                  |       | (35,866                                                 | )          | 41,116 |   |
| Deferred revenue                                                                   |       | (4,400                                                  | )          | (33,775 | ) |
| Other liabilities                                                                  |       | (54,413                                                 | )          | (15,757 | ) |
| Net cash used in operating activities                                              |       | (97,405                                                 | )          | (89,202 | ) |
|                                                                               |       |                                                    |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                              |       |                                                    |       |   |   |
| Additions to property, plant and equipment                                         |       | (2,616                                                  | )          | (1,651 | ) |
| Net proceeds from divestitures                                                     |       | 2,848                                                   |       | 11,508 |   |
| Proceeds from sale of building, net of tax  payments                               |       | 123,955                                                 |       | — |   |
| Change in restricted cash                                                          |       | 7,379                                                   |       | 1,895 |   |
| Proceeds from settlement of an investment interest                                 |       | 481                                                     |       | 1,600 |   |
| Purchase of an investment interest                                                 |       | (550                                                    | )          | — |   |
| Purchase of short-term investments                                                 |       | (12,002                                                 | )          | (6,514 | ) |
| Proceeds from sale of short-term investments                                       |       | 7,825                                                   |       | 7,625 |   |
| Other                                                                              |       | 332                                                     |       | 437 |   |
| Net cash provided by investing activities                                          |       | 127,652                                                 |       | 14,900 |   |
|                                                                               |       |                                                    |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                              |       |                                                    |       |   |   |
| Issuance of common stock and option per stock  purchase agreement , net of expense |       | 34,587                                                  |       | — |   |
| Issuance of common stock upon exercise of options  and ESPP                        |       | 7                                                       |       | 367 |   |
| Repurchase of common stock                                                         |       | (58                                                     | )          | — |   |
| Other                                                                              |       | —                                                  |       | (755 | ) |
| Net cash provided by (used in) financing  activities                               |       | 34,536                                                  |       | (388 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                      |       | 6,400                                                   |       | 2,199 |   |
| Net increase (decrease) in cash and cash  equivalents                              |       | 71,183                                                  |       | (72,491 | ) |
| Cash and cash equivalents at beginning of period                                   |       | 265,843                                                 |       | 309,603 |   |
| Cash and cash equivalents at end of period                                         |       | $                                                       | 337,026    |   | $ | 237,112 |   |

 

See accompanying notes to the condensed consolidated financialstatements.

 

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**UTSTARCOM, INC.**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

**NOTE 1 - BASIS OF PRESENTATION AND LIQUIDITY**

 

Theaccompanying unaudited condensed consolidated financial statements include theaccounts of UTStarcom, Inc. (“Company”) and its wholly and majority ownedsubsidiaries. All significant intercompany accounts and transactions have beeneliminated in the preparation of the condensed consolidated financialstatements. The noncontrolling interests in consolidated subsidiaries are shownseparately in the condensed consolidated financial statements.

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared by the Company pursuant to the rules and regulations of theSecurities and Exchange Commission (“SEC”). Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith generally accepted accounting principles in the United States (“GAAP”)have been condensed or omitted pursuant to such rules and regulations. TheDecember 31, 2009 condensed consolidated balance sheet was derived fromaudited financial statements, but does not include all disclosures required byaccounting principles generally accepted in the United States. However, theCompany believes that the disclosures are adequate to make the informationpresented not misleading. These condensed consolidated financial statementsshould be read in conjunction with the Company’s December 31, 2009financial statements, including the notes thereto, and the other informationset forth in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2009. The preparation of financial statements in conformitywith GAAP requires management to make estimates and assumptions that affect theamounts reported in the consolidated financial statements and accompanyingnotes. Actual results may be different. See the Company’s 2009 Annual Reportfor discussion of the Company’s critical accounting policies and estimates.

 

Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements reflect all adjustments (consisting of only normalrecurring adjustments) considered necessary for a fair statement of the Company’sfinancial condition, the results of its operations and its cash flows for theperiods indicated. The results of operations for the three and nine monthsended September 30, 2010 are not necessarily indicative of the operatingresults for the full year.

 

InDecember 2009, the Company entered into a Sales Leaseback Agreement forthe sale of its manufacturing, research and development, and administrativeoffices facility in Hangzhou, China to a third party for approximately $138.8 millionwith leaseback of approximately one-third of the facility. On May 31,2010, the Company and the buyer agreed that all conditions precedent to theclosing had been met, the sale was consummated and the leaseback commenced onJune 1, 2010. As of May 31, 2010, the Company had received all of thesales proceeds. See Note 7 for additional information on sale-leasebacktransaction.

 

OnFebruary 1, 2010, the Company entered into agreements for a strategicrelationship with Beijing E-town International Investment andDevelopment Co., Ltd (“BEIID”) which included a proposed investmentof $48.5 million in the Company’s common stock by BEIID, and two unrelatedinvestment funds, Elite Noble Limited and Shah Capital OpportunityFund LP. These investment transactions closed in September 2010.Under the revised terms, UTStarcom received cash of $34.6 million, net ofissuance costs, and issued approximately 18.1 million shares of common stockand an option to purchase up to an additional 4.0 million shares of commonstock for approximately $8.1 million through November 8, 2010. See Note 11for additional information.

 

Managementbelieves that both the Company’s China and non-China operations have sufficientliquidity to finance working capital and capital expenditure needs during thenext 12 months. There can be no assurance that additional financing, ifrequired, will be available on terms satisfactory to the Company or at all, andif funds are raised in the future through issuance of preferred stock or debt,these securities could have rights, privileges or preference senior to those ofthe Company’s common stock and newly issued debt could contain debt covenantsthat impose restrictions on the Company’s operations. Further, any sale ofnewly issued debt or equity securities could result in additional dilution tothe Company’s current shareholders.

 

**NOTE****2 - ACCOUNTING POLICIES AND RECENT ACCOUNTINGPRONOUNCEMENTS**

 

***Earnings Per Share***

 

Basic earnings per share (“EPS”)is computed by dividing net income (loss) available to common stockholders bythe weighted average number of shares of the Company’s common stock outstandingduring the period, which excludes nonvested restricted stock. Diluted EPSpresents the amount of net income (loss) available to each share of commonstock outstanding during the period plus each share of common stock that wouldhave been outstanding assuming the Company had issued shares of common stockfor all dilutive potential common shares outstanding during the period. TheCompany’s potentially dilutive common shares include outstanding stock options,nonvested restricted stock, restricted stock units and Employee Stock PurchasePlan (“ESPP”) shares prior

 

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to termination of the ESPPeffective May 15, 2009, which are reflected in diluted net income pershare by application of the treasury stock method. Under the treasury stockmethod, the amount that the employee must pay for exercising stock options, theamount of stock-based compensation cost for future services that the Companyhas not yet recognized, and the amount of tax benefit that would be recorded inadditional paid-in capital upon exercise are assumed to be used to repurchaseshares. For the three and nine months ended September 30, 2010 and 2009,no potential common shares were dilutive because of the net loss in theperiods. Potential shares of common stock of approximately 7.6 million and 11.4million were excluded from the diluted per share calculation for the threemonths ended September 30, 2010 and 2009, respectively, while 8.4 millionand 13.3 million were excluded from the diluted per share calculation for thenine months ended September 30, 2010 and 2009, respectively, because toinclude them would have been anti-dilutive for the periods. In addition,potentially dilutive common shares from the investor option to purchase up toan additional 4.0 million shares through November 8, 2010 (see Note 11)were also excluded from the diluted per share calculation for the three andnine months ended September 30, 2010 because to include them would havebeen anti-dilutive for the periods.

 

***Fair Value***

 

Pursuantto the accounting guidance for fair value measurements and its subsequentupdates, fair value is defined as the price that would be received from sellingan asset or paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date. As such, fair value is amarket-based measurement that should be determined based on assumptions thatmarket participants would use in pricing an asset or liability. Theaccounting guidance also establishes a three-tier fair value hierarchy whichrequires the Company to use observable market data, when available, and tominimize the use of unobservable inputs when determining fair value. The fairvalue hierarchy prioritizes the inputs into three levels that may be used inmeasuring fair value as follows:

 

Level1 - observable inputs such as quoted prices in active markets for identicalassets or liabilities.

 

Level2 - inputs other than the quoted prices in active markets for identical assetsor liabilities that are observable either directly or indirectly.

 

Level3 - unobservable inputs based on the Company’s assumptions.

 

InJanuary 2010, the Financial Accounting Standards Board (“FASB”) issuedamended standards that require additional fair value disclosures. Thesedisclosure requirements are effective in two phases. In the first quarter of2010, the Company adopted the requirements for disclosures about inputs andvaluation techniques used to measure fair value as well as disclosures aboutsignificant transfers between hierarchy levels. Beginning in the first quarterof 2011, these amended standards will require presentation of disaggregatedactivity within the reconciliation for fair value measurements usingsignificant unobservable inputs (Level 3). These amended standards do notsignificantly impact the Company’s consolidated financial statements.

 

AtSeptember 30, 2010, the Company had no assets and liabilities measured atfair value on a recurring basis. The Company’s money market funds, which areincluded in cash and cash equivalents, are recorded at cost which approximatesfair value, classified within Level 1 of the fair value hierarchy. Thefair value of certain of the Company’s financial instruments that are notmeasured at fair value, including accounts receivable, accounts payable, andother current liabilities, approximates the carrying amount because of theirshort maturities.

 

Duringthe nine months ended September 30, 2010, the Company had no assets andliabilities measured at fair value on a non-recurring basis. AtDecember 31, 2009, the Company determined as a result of the saleleaseback transaction entered into in December 2009 (see Note 7) that thenet book value of its Hangzhou facility was in excess of its fair value. Due tothe apparent decline in value, the Company conducted a recoverability test forthis entity-wide asset and determined the carrying value of the net assets ofthe Company exceeded the undiscounted cash flows expected to result from theuse and eventual disposition of the asset group. In the Company’s assessment offair value, management placed primary reliance on the market approach (thethird party offer). The result of this analysis reduced the Company’s overallassessment of fair value of the property by $33.3 million. Accordingly,the Company recorded a non-cash impairment charge of $33.3 million duringthe fourth quarter of 2009. The Company’s overall assessment of fair value ofthe property at December 31, 2009 was based on Level 2 inputs.

 

***Variable Interest Entities***

 

InJune 2009, the FASB issued authoritative guidance requiring an enterpriseto perform an analysis to determine whether the enterprise’s variable interestor interests give it a controlling financial interest in a variable interestentity. This analysis identifies the primary beneficiary of a variable interestentity as one with the power to direct the activities of a variable interestentity that most significantly impact the entity’s economic performance and theobligation to absorb losses of the entity that could potentially be significantto the variable interest. The Company adopted this new standard in the firstquarter of fiscal year 2010. See Note 18 for the impact of the adoption of theguidance on the Company’s consolidated financial statements.

 

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***Recent Accounting Pronouncements Not YetAdopted***

 

InSeptember 2009, the FASB issued new standards for revenue recognition withmultiple deliverables. These new standards impact the determination of when theindividual deliverables included in a multiple-element arrangement may betreated as separate units of accounting. Additionally, these new standardsmodify the manner in which the transaction consideration is allocated across theseparately identified deliverables by no longer permitting the residual methodof allocating arrangement consideration. These new standards are effective forthe Company beginning in the first quarter of fiscal year 2011, however earlyadoption is permitted. The Company will adopt these standards in the firstquarter of fiscal year 2011 and is currently assessing the potential impact, ifany, of the guidance on its consolidated financial statements.

 

InSeptember 2009, the FASB issued new standards for the accounting forcertain revenue arrangements that include software elements. These newstandards amend the scope of pre-existing software revenue guidance by removingfrom the guidance non-software components of tangible products and certainsoftware components of tangible products. These new standards are effective forthe Company beginning in the first quarter of fiscal year 2011, however earlyadoption is permitted. The Company will adopt these standards in the firstquarter of fiscal year 2011 and is currently assessing the potential impact, ifany, of the guidance on its consolidated financial statements.

 

**NOTE 3—DIVESTITURES**

 

*ChinaPacket Data Services Node (“PDSN”) Assets*

 

Inthe third quarter of 2010, the Company completed a sale of its China PDSN assets.The divested assets were part of the Multimedia Communications segment. Afterthe close of the transactions, the Company remained the primary obligor forcertain sales contracts that were in place prior to the close of thetransaction. The Company allocated proceeds to each component of the salesagreement based on relative fair values and recorded a gain of $1.6 millionupon closing of the transaction in September 2010.  The Company will record sales and relatedcost of net sales in future periods related to the completion of existingcontracts. The Company determined that the sale of this product line did notmeet the criteria for presentation as a discontinued operation because of theCompany’s continuing involvement.

 

*EMEAOperations*

 

In September 2010, the Company entered into an agreement totransfer its EMEA (“Europe, Middle East and Africa”) operations for noconsideration. However as of September 30, 2010, the transaction was notcompleted because the Company did not transfer its obligations under theexisting sales contracts to the buyer. In the third quarter of 2010, theCompany recognized expenses of approximately $0.9 million as an operatingexpense for its obligations primarily arising out of local statutoryrequirements such as severance fund for transferred employees and othermiscellaneous costs. In the third quarter of 2010, the Company paidapproximately $0.3 million to the buyer with the remaining accrued balance of$0.6 million expected to be paid in the fourth quarter of 2010 because thebuyer has agreed to take over these obligations. The Company determined thatthe sale of its EMEA operations did not meet the criteria for presentation as adiscontinued operation because EMEA did not meet the definition of a componentof an entity and, the Company continues to have involvement with EMEAoperations as of September 30, 2010.

 

*IP Messagingand US PDSN Assets*

 

In June 2010, the Company completed a sale of its IP Messaging andUS PDSN Assets as part of its strategy to focus on core IP-based productofferings. The divested assets were located in North America, Caribbean, and LatinAmerica regions and were part of the Multimedia Communications segment.Consideration for the approximately $1.7 million of net liabilities transferredincluded approximately $0.4 million cash proceeds plus potential additionalcontingent consideration of up to $1.6 million based on future cash collectionof transferred receivables. A gain of $2.1 million, net of taxes, wasrecognized in June 2010 as a reduction to operating expenses. In the thirdquarter of 2010, the Company received $0.7 million of contingent considerationand recognized an additional gain on divestiture. The Company determined thatthe sale of these product lines did not meet the criteria for presentation as adiscontinued operation as these product lines did not meet the definition of acomponent of an entity.

 

*Sale of Remote Access Server product line*

 

InJanuary 2010, the Company completed a sale of certain assets andliabilities related to its Remote Access Server (“RAS”) product line andreceived total consideration of approximately $1.5 million. The primaryRAS product was the Total Control 1000 Transaction Gateway, which offers themarket a proven processing platform for carrier-class transaction networkservice providers and enterprises for dial-up connectivity. In the firstquarter of 2010, the Company transferred net liabilities of approximately $0.3million in connection with this transaction and recorded a net gain of$1.8 million as a reduction of operating expenses. The Company determinedthat the divestiture of the RAS product line did not meet the criteria forpresentation as a discontinued operation as the RAS product line did not meetthe definition of component of an entity.

 

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*UTStarcom Personal Communications LLC (PCD)*

 

On July 1, 2008, the Company completed the sale of UTStarcomPersonal Communications LLC, a wholly-owned subsidiary of the Company (“PCD”),to Personal Communications Devices, LLC (“PCD LLC”). Concurrent withthe closing of the divestiture transaction, the Company entered into athree-year supply agreement with PCD LLC whereby the Company indicated itsintent to supply handset products to PCD LLC. In connection with the winddown of our Korea operations, in December 2008, we furnished PCD LLC with180-day’s notice of termination of the supply agreement.

 

On June 30, 2009, the Company entered into a Settlement Agreementand Release (the “Settlement Agreement”) with PCD LLC. Under the SettlementAgreement, the Company waived its right to any earnout payments and granted acall option to PCD LLC for the Company’s $1.6 million investment in the equitysecurities of PCD LLC.  The Company alsoagreed to pay PCD LLC a total of $11.1 million which included warranty costs ofapproximately $8.4 million (see Note 8) and a reduction of revenue ofapproximately $2.7 million. In addition to the $11.1 million claim settlement,the Company recorded an additional $17.6 million of costs for inventorywrite-downs to net realizable value, write-downs of excess inventory andwarranty reserves related to transactions with PCD LLC. The Company recordedthese transactions in the second quarter of 2009, resulting in a decrease inrevenue of approximately $2.7 million and an increase in cost of net sales of$26.0 million. The sale of the PCD assets did not meet the criteria forpresentation as a discontinued operation because of the Company’s significantcontinuing involvement.

 

*Korea operations*

 

OnJuly 31, 2009, the Company completed a sale of its Korea operations to anentity founded by a former employee and received total consideration ofapproximately $2.0 million. In connection with this transaction, theCompany recorded a net loss of $1.3 million during 2009. Included in thisamount was $2.2 million of foreign currency losses previously carried inaccumulated other comprehensive income that were realized upon completion ofsale and liquidation of the subsidiary. The Company determined that thedivestiture of Korea operations did not meet the criteria for presentation as adiscontinued operation as the Korea operations did not meet the definition ofcomponent of an entity.

 

*Sale of Assets to Marvell Technology Group Ltd*

 

InFebruary 2006, the Company sold substantially all of the assets andselected liabilities of its semiconductor design business division to MarvellTechnology Group Ltd. (“Marvell”). In connection with the sale of assets,the Company entered into a supply agreement with Marvell to purchase chipsetsfor the Company’s handset products over the next five years. The valueallocated to the supply agreement of $20.2 million has been amortized inproportion to the quantities of chipsets purchased under the supply agreement.During the first quarter of 2009, the Company revised its estimates of customerdemand for certain handset products and determined that future chipsetpurchases from Marvell would be negligible. As a result, the Company fullyamortized against cost of net sales the remaining value of the supply agreementof $8.5 million in the three months ended March 31, 2009.

 

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**NOTE 4 - COMPREHENSIVE LOSS**

 

Totalcomprehensive loss for the three and nine months ended September 30, 2010and 2009 consisted of the following:

 
| ** **                                                                                                 | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                                                 | ** ** | **(in thousands)**                              | ** ** |
| Net loss                                                                                                   |       | $                                                    | (17,168    | )                                                   | $          | (34,595 | ) | $ | (42,106 | ) | $ | (186,328 | ) |
| Other Comprehensive income                                                                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Unrealized gain on investments, net of tax                                                                 |       | —                                               |       | 714                                                 |       | — |   | 714 |   |
| Reclassification for realization of previously  unrealized losses, net of tax                              |       | —                                               |       | —                                              |       | — |   | 3,313 |   |
| Reclassification for realization of previously  unrealized foreign currency translation losses, net of tax |       | —                                               |       | 2,360                                               |       | — |   | 2,164 |   |
| Foreign currency translation                                                                               |       | (2,712                                               | )          | 1,641                                               |       | (1,404 | ) | (247 | ) |
| Comprehensive loss                                                                                         |       | (19,880                                              | )          | (29,880                                             | )          | (43,510 | ) | (180,384 | ) |
|                                                                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Comprehensive loss attributable to noncontrolling  interests                                               |       | 4                                                    |       | (15                                                 | )          | (6 | ) | (32 | ) |
| Comprehensive loss attributable to  UTStarcom, Inc.                                                   |       | $                                                    | (19,884    | )                                                   | $          | (29,865 | ) | $ | (43,504 | ) | $ | (180,352 | ) |

 

Thechanges in noncontrolling interests during the nine months endedSeptember 30, 2010 and 2009 were as follows:

 
| ** **                                                   | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**                                 | ** ** |
| Balance at beginning of period                               |       | $                                                       | 792        |   | $ | 808 |   |
| Comprehensive loss attributable to noncontrolling  interests |       | (6                                                      | )          | (32 | ) |
| Balance at end of period                                     |       | $                                                       | 786        |   | $ | 776 |   |

 

**NOTE****5 — BALANCE SHEET DETAILS**

 

The following tables provide details of selectedbalance sheet items:

 
| ** **         | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|--------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **         | ** ** | **2010**                | ** ** | **2009**              | ** ** |
| ** **         | ** ** | **(in thousands)** | ** ** |
| **Inventories:**   | ** ** | ** **              | ** ** | ** **            | ** ** |
| Raw materials      |       | $                       | 4,733      |                  | $          | 18,863 |   |
| Work in process    |       | 14,967                  |       | 12,881                |       |
| Finished goods (1) |       | 32,157                  |       | 40,556                |       |
| Total              |       | $                       | 51,857     |                  | $          | 72,300 |   |

 

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(1)                                  Includes finished goods atcustomer sites of approximately $21.4 million and $33.8 million atSeptember 30, 2010 and December 31, 2009, respectively, for which thecustomer has taken possession, but based on specific contractual terms, titlehas not yet passed to the customer.

 

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Inventoriesof approximately $0.8 million held by the Company’s manufacturing outsourcepartner are recorded in prepaids and other current assets in the condensedconsolidated balance sheet at September 30, 2010. No inventories were heldby our manufacturing outsource partner at December 31, 2009. The Companyrecorded an $8.5 million inventory reserves in the third quarter of 2010 forMSAN and MSTP for two international customer contracts due to the reduction inproduct demands.

 
| ** **                                    | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2010**                | ** ** | **2009**              | ** ** |
| ** **                                    | ** ** | **(in thousands)** | ** ** |
| **Property, plant and equipment,  net:**      | ** ** | ** **              | ** ** | ** **            | ** ** |
| Buildings                                     |       | $                       | 238        |                  | $          | 184,436 |   |
| Leasehold improvements                        |       | 11,290                  |       | 15,422                |       |
| Automobiles                                   |       | 4,186                   |       | 4,243                 |       |
| Software                                      |       | 33,301                  |       | 37,240                |       |
| Equipment and Furniture                       |       | 121,489                 |       | 172,214               |       |
| Others                                        |       | 811                     |       | 1,690                 |       |
| Total                                         |       | 171,315                 |       | 415,245               |       |
| Less: accumulated depreciation and impairment |       | (166,505                | )          | (284,633              | )          |
| Total (see Note 7)                            |       | $                       | 4,810      |                  | $          | 130,612 |   |

 
| ** **                            | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2010**                | ** ** | **2009**              | ** ** |
| ** **                            | ** ** | **(in thousands)** | ** ** |
| **Other current liabilities:**        | ** ** | ** **              | ** ** | ** **            | ** ** |
| Accrued contract costs                |       | $                       | 13,429     |                  | $          | 27,657 |   |
| Accrued payroll and compensation      |       | 22,421                  |       | 35,871                |       |
| Warranty costs                        |       | 8,287                   |       | 16,150                |       |
| Accrued other taxes                   |       | 16,281                  |       | 15,863                |       |
| Restructuring costs                   |       | 5,403                   |       | 21,707                |       |
| Deposit received for sale of building |       | —                  |       | 7,323                 |       |
| Other                                 |       | 17,539                  |       | 18,323                |       |
| Total                                 |       | $                       | 83,360     |                  | $          | 142,894 |   |

 

**NOTE 6 - CASH, CASH EQUIVALENTS, INVESTMENTS AND FAIRVALUE MEASUREMENTS**

 

Cashand cash equivalents, consisting primarily of bank deposits and money marketfunds, are recorded at cost which approximates fair value because of theshort-term nature of these instruments. At September 30, 2010 andDecember 31, 2009, there were no available-for-sale securities investmentssubject to fair value accounting included in cash and cash equivalents orlong-term investments.

 

Short-terminvestments, consisting of bank notes, were $1.0 million and $1.0 millionat September 30, 2010 and December 31, 2009, respectively. TheCompany accepts bank notes receivable with maturity dates of between three andsix months from its customers in China in the normal course of business. TheCompany may discount these bank notes with banking institutions in China.During the nine months ended September 30, 2010, no bank notes were sold.During the three months ended September 30, 2009, there were no bank notessold. During the nine months ended September 30, 2009, the Company sold$9.9 million of bank notes and recorded immaterial costs as a result ofdiscounting the notes. All long-term investments are in privately-heldcompanies and are accounted for under the cost method. The Company recognizesan impairment charge when a decline in the fair value of its investments belowthe cost basis is judged to be other-than-temporary. In making thisdetermination, the Company reviews several factors to determine whether thelosses are other-than-temporary, including but not limited to: (i) thelength of time the investment was in an unrealized loss position, (ii) theextent to which fair value was less than cost, (iii) the financialcondition and near term prospects of the issuer and (iv) the Company’sintent and ability to hold the investment for a period of time sufficient toallow for any anticipated recovery in fair value.

 

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Thefollowing table shows the break-down of the Company’s equity securitiesclassified as long-term investments at September 30, 2010 andDecember 31, 2009:

 
| ** **                  | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2010**                | ** ** | **2009**              | ** ** |
| ** **                  | ** ** | **(in thousands)** | ** ** |
| ** **                  | ** ** | ** **              | ** ** | ** **            | ** ** |
| Cortina                     |       | $                       | 3,348      |                  | $          | 3,348 |   |
| GCT SemiConductor, Inc |       | 3,000                   |       | 3,000                 |       |
| Xalted Networks             |       | 1,583                   |       | 1,583                 |       |
| SBI                         |       | 1,198                   |       | 471                   |       |
| Total equity securities     |       | $                       | 9,129      |                  | $          | 8,402 |   |

 

*SBI NEOTechnology A Investment LPS (“SBI”)*

 

In2008, the Company invested $0.5 million into SBI in exchange forapproximately 2% of the Partnership interest. The Partnership’s investmentobjective is to invest in unlisted or listed companies in Japan and overseasthat are engaged in high growth businesses, including businesses focused oninformation technology and the environment. In the first quarter of 2010, theCompany contributed an additional $0.6 million into SBI, and atSeptember 30, 2010 maintains an approximately 2% Partnership interest. TheCompany has concluded that it does not have a controlling interest in SBI as itdoes not have the power to direct the activities of SBI that most significantlyimpact the entity’s economic performance. Affiliates of a related party have acontrolling interest in SBI, see Note 17. The Company accounts for theinvestment in SBI using the cost method.

 

**NOTE 7 — SALE-LEASEBACK TRANSACTION**

 

InDecember 2009, the Company entered into a Property Transfer and LeasebackAgreement (the “Sale Leaseback Agreement”) for the sale of its manufacturing,research and development and administrative office facility in Hangzhou, China(the “Hangzhou facility”) to a third party for proceeds of approximately$138.8 million and the leaseback of approximately one-third of theproperty through 2016. As of May 31, 2010, the Company had received all ofthe sales proceeds and met all criteria for consummation of sale of the Hangzhoufacility. On May 31, 2010, the Company and the buyer agreed that allconditions precedent to the closing had been met and the leaseback commenced onJune 1, 2010.

 

Managementconcluded that the transaction qualified for sale-leaseback accounting as allof the risks and rewards of ownership were transferred to the buyer uponclosing of the transaction and the leaseback arrangement did not include anyform of continuing involvement, other than a normal leaseback. In the secondquarter of 2010, the Company recorded the sale of the Hangzhou facility andrecorded a deferred gain of $7.7 million at the time of sale. The deferred gainwas represented by the gross sales proceeds of $138.8 million, less $7.5million of transaction related taxes and other fees, and less the net bookvalue of the Hangzhou facility of $123.6 million. The gain on sale was deferredin accordance with the accounting guidance for sale-leaseback transactions, asthe Company has retained more than a minor portion of the use of the propertythrough the six-year leaseback. The deferred gain on the sale-leaseback isbeing amortized in proportion to the related gross rental charged to expenseover the leaseback term. During the three and nine months ended September 30,2010, amortization of the deferred gain of $0.3 million and $0.4 million,respectively, was recorded as a reduction of operating expenses. AtSeptember 30, 2010, $1.2 million of deferred gain is included in othercurrent liabilities and $6.1 million of deferred gain is included in otherlong-term liabilities in the condensed consolidated balance sheet.

 

Inconnection with the Sale Leaseback Agreement, on February 1, 2010, theCompany entered into a Lease Contract (the “Lease”) with respect to theleaseback of a portion of the Hangzhou facility. Under the terms of the Lease,the Company will lease back 71,027 sqm gross floor area (“GFA”) aboveground and12,000 sqm GFA underground of the building for a period of 6 years at arate of approximately $0.37, $0.44 and $0.47, respectively, per sqm per day foryears 1-2, 3-4 and 5-6, respectively, of the lease period for the abovegroundspace; and approximately $3.66 per sqm per month for the underground space forthe full lease period. The Company was also required to pay a security depositin the amount of approximately $1.8 million and prepay part of the rentand fees for the last six months of the lease term in the amount ofapproximately $3.4 million upon lease inception on June 1, 2010. TheCompany may terminate all or part of the Lease by giving six months advancenotice; however, the Company would be required to pay penalties and additionalcompensation in the event of early termination. The Company has concluded thatthe Lease qualifies as an operating lease. See Note 10 for future minimum lease payments under allnoncancelable operating leases.

 

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**NOTE 8 - WARRANTY OBLIGATIONS AND OTHER GUARANTEES**

 

The Company provides a standard warranty on its equipment and handsetsales for a period generally ranging from one to two years from the time offinal acceptance. At times, the Company has entered into arrangements toprovide limited warranty services for periods longer than two years. TheCompany provides for the expected cost of product warranties at the time thatrevenue is recognized based on an assessment of past warranty experience andwhen specific circumstances dictate. The Company assesses the adequacy of itsrecorded warranty liability every quarter and makes adjustments to theliabilities if necessary. Specific warranty accruals are reversed upon theexpiration of the warranty period and are recorded as a reduction of cost ofnet sales. From time to time, the Company may be subject to additional costsrelated to non-standard warranty claims from its customers. If and when thisoccurs, the Company estimates additional accruals based on historicalexperience, communication with its customers and various assumptions that theCompany believes to be reasonable under the circumstances. Such additionalwarranty accruals are recorded in the period in which the additional costs areidentified.

 

Expirationsrecorded as a reduction of cost of net sales approximated $0.4 million and $0.6million for the three months ended September 30, 2010 and 2009,respectively, and $3.0 million and $2.9 million for the nine months endedSeptember 30, 2010 and 2009, respectively and are included in the tablebelow as benefit from expirations. The following table summarizes the activityrelated to warranty obligations during the three and nine months endedSeptember 30, 2010 and 2009:

 
| ** **                                                                        | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                        | ** ** | **(in thousands)**                              | ** ** |
| Balance at beginning of period                                                    |       | $                                                    | 9,592      |                                                | $          | 33,824 |   | $ | 16,150 |   | $ | 29,840 |   |
| Accruals for warranties issued during the period  (benefit from expirations), net |       | (339                                                 | )          | (1,124                                              | )          | (3,423 | ) | 9,709 |   |
| Settlements made during the period                                                |       | (966                                                 | )          | (10,057                                             | )          | (4,440 | ) | (16,906 | ) |
| Balance at end of period                                                          |       | $                                                    | 8,287      |                                                | $          | 22,643 |   | $ | 8,287 |   | $ | 22,643 |   |

 

During the second quarter of 2009, the Company recorded a specialwarranty charge related to certain handsets sold to PCD LLC.  Under the Settlement Agreement with PCD LLC (seeNote 3), the Company agreed to pay PCD LLC $8.4 million to settle certain PCDLLC customers’ warranty claims arising from the handsets sold to PCD LLC.  The $8.4 million claim settlement is includedin the accruals for warranties issued during the three and nine months endedSeptember 30, 2009 in the table above.

 

Certainof the Company’s sales contracts include provisions under which customers wouldbe indemnified by the Company in the event of, among other things, athird-party claim against the customer for intellectual property rightsinfringement related to the Company’s products. There are no limitations on the maximum potential future payments underthese guarantees.  Historically, theCompany has not incurred material costs as a result of obligations under theseagreements.  It is not possible todetermine the aggregate maximum potential loss under these indemnificationagreements due to the limited history of prior indemnification claims and theunique facts and circumstances involved in each particular agreement.

 

**NOTE 9 - RESTRUCTURING COSTS**

 

***Restructuring Costs***

 

During the three months and nine months endedSeptember 30, 2010, the Company recorded approximately $2.3 million and$9.6 million respectively in restructuring charges. For the three and ninemonths ended September 30, 2009, the Company recorded restructuring charges of $8.9 million and$41.5 million, respectively.  Thefollowing describes the Company’s restructuring initiatives.

 

*2009 Restructuring Plan*

 

OnJune 9, 2009, the Board of Directors of the Company approved arestructuring plan (the “2009 Restructuring Plan”) designed to reduce theCompany’s operating costs. The 2009 Restructuring Plan includes a worldwidereduction in force of approximately 50% of the Company’s headcount, orapproximately 2,300 employees located primarily in China and the United Statesand, to a lesser degree, other international locations. During the three monthsended September 30, 2010, the Company recorded restructuring costs ofapproximately $2.2 million related to the 2009 Restructuring Plan, net ofapproximately $0.2 million of reversal of charges recorded in fiscal year 2009.During the nine months ended September 30, 2010, the Company recordedrestructuring costs of approximately $9.1 million related to the 2009Restructuring Plan, net of approximately $1.9 million of reversal of charges

 

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recordedin prior periods. The restructuring costs for the nine months endedSeptember 30, 2010 consist primarily of severance and benefits related toadditional employees included in the 2009 Restructuring Plan, adjusted forchange in estimate, and approximately $1.1 million of lease costs primarilyrelated to a lease expiring in 2013. During the three and nine months endedSeptember 30, 2009, the Company recorded restructuring costs ofapproximately $9.2 million and $35.1 million, respectively, relatedto the 2009 Restructuring Plan. Restructuring costs for the nine months ended September 30, 2009included $33.6 million forseverance and benefits related to approximately 2,070 employees and $1.5 million related primarily to theestimated loss on a lease obligation which expires in 2013.Total restructuringcosts recorded through September 30, 2010 related to the 2009 Restructuring**Plan approximated $49.1 million.

 

*2008 Restructuring Plan*

 

During fiscal 2008, the Company implemented a restructuring plan (the “2008Restructuring Plan”) primarily related to a global reduction in force acrossall functions and employee terminations at certain non-core operations whichthe Company was in the process of winding down. The total number of employeesaffected totaled approximately 750, including 350 in China, 200 in Korea and200 in other locations including the United States. During the three and ninemonths ended September 30, 2010, the Company recorded additionalrestructuring costs related to the 2008 Restructuring Plan of approximately$0.1 million and $0.5 million, respectively, for severance and benefitcosts being recognized over the remaining service period for employees includedin the 2008 Restructuring Plan. During the three and nine months endedSeptember 30, 2009, the Company recorded a reversal of $0.3 million and acharge of $6.1 million, respectively, in restructuring charges related to the2008 Restructuring Plan. Total restructuring costs recorded throughSeptember 30, 2010 related to the 2008Restructuring**Planapproximated $19.9 million.

 

*2007 Restructuring Plan*

 

At June 30, 2010, the 2007 Restructuring Plan was complete.

 

The activity in the accrued restructuring balances related to the plansdescribed above was as follows for the nine months ended September 30,2010 and 2009:

 
| ** **                            | ** ** | **Balance at  December 31,  2009** | ** ** | **Restructuring  Charges** | ** ** | **Cash Payments** | ** ** | **Non-cash  Settlement** | ** ** | **Balance at  September 30,  2010** | ** ** |
|---------------------------------------|------------|----------------------------------------------|------------|----------------------------|------------|------------------------|------------|--------------------------|------------|-----------------------------------------------|------------|
| ** **                            | ** ** | **(in thousands)**                      | ** ** |
| 2009 Restructuring Plan               | ** ** | ** **                                   |       |                       |       |                   |       |                     |       |                                          |       |
| Workforce Reduction                   |       | $                                            |       | 16,939                     |       | $                      |       | 8,066                    |       | $                                             |       | (19,907 | ) | $ |   | (2,052 | ) | $ |   | 3,046 |   |
| Lease Costs                           |       | 1,516                                        |       | 1,052                      |       | (456                   | )          | —                   |       | 2,112                                         |       |
| Other Costs                           |       | 6                                            |       | 45                         |       | —                 |       | (45                      | )          | 6                                             |       |
| Total 2009 Restructuring Plan         |       | 18,461                                       |       | 9,163                      |       | (20,363                | )          | (2,097                   | )          | 5,164                                         |       |
|                                  |       |                                         |       |                       |       |                   |       |                     |       |                                          |       |
| 2008 Restructuring Plan               | ** ** | ** **                                   |       |                       |       |                   |       |                     |       |                                          |       |
| Workforce Reduction                   |       | 2,526                                        |       | 494                        |       | (2,781                 | )          | —                   |       | 239                                           |       |
| Lease Costs                           |       | 385                                          |       |                       |       | (385                   | )          | —                   |       | —                                        |       |
| Other Costs                           |       | 30                                           |       | (30                        | )          | —                 |       | —                   |       | —                                        |       |
| Total 2008 Restructuring Plan         |       | 2,941                                        |       | 464                        |       | (3,166                 | )          | —                   |       | 239                                           |       |
|                                  |       |                                         |       |                       |       |                   |       |                     |       |                                          |       |
| 2007 Restructuring Plan - Lease Costs |       | 305                                          |       | —                     |       | (305                   | )          | —                   |       | —                                        |       |
|                                  |       | —                                       |       |                       |       |                   |       |                     |       | —                                        |       |
| Total                                 |       | $                                            |       | 21,707                     |       | $                      |       | 9,627                    |       | $                                             |       | (23,834 | ) | $ |   | (2,097 | ) | $ |   | 5,403 |   |

 
| ** **                             | ** ** | **Balance at  December 31,  2008** | ** ** | **Restructuring  Charges** | ** ** | **Cash Payments** | ** ** | **Non-cash  Settlement** | ** ** | **Balance at  September 30,********2009** | ** ** |
|----------------------------------------|------------|----------------------------------------------|------------|----------------------------|------------|------------------------|------------|--------------------------|------------|-----------------------------------------------------|------------|
| ** **                             | ** ** | **(in thousands)**                      | ** ** |
|                                   |       |                                         |       |                       |       |                   |       |                     |       |                                                |       |
| 2009  Restructuring Plan               | ** ** | ** **                                   |       |                       |       |                   |       |                     |       |                                                |       |
| Workforce  Reduction                   |       | $                                            | —     |                       | $          | 33,620                 |       | $                        | (13,542    | )                                                   | $          | (1,569 | ) | $ | 18,509 |   |
| Lease  Costs                           |       | —                                       |       | 1,516                      |       | (215                   | )          | **—**               |       | 1,301                                               |       |
| Other  Costs                           |       | —                                       |       | 7                          |       | (7                     | )          | —                   |       | —                                              |       |
| Total  2009 Restructuring Plan         |       | —                                       |       | 35,143                     |       | (13,764                | )          | (1,569                   | )          | 19,810                                              |       |
|                                   |       |                                         |       |                       |       |                   |       |                     |       |                                                |       |
| 2008  Restructuring Plan               | ** ** | ** **                                   |       |                       |       |                   |       |                     |       |                                                |       |
| Workforce  Reduction                   |       | 7,976                                        |       | 5,189                      |       | (9,278                 | )          | (880                     | )          | 3,007                                               |       |
| Lease  Costs                           |       | 249                                          |       | 1,075                      |       | (703                   | )          | **—**               |       | 621                                                 |       |
| Other  Costs                           |       | 498                                          |       | (126                       | )          | (314                   | )          | —                   |       | 58                                                  |       |
| Total  2008 Restructuring Plan         |       | 8,723                                        |       | 6,138                      |       | (10,295                | )          | (880                     | )          | 3,686                                               |       |
|                                   |       |                                         |       |                       |       |                   |       |                     |       |                                                |       |
| 2007  Restructuring Plan - Lease Costs |       | 788                                          |       | 204                        |       | (504                   | )          | —                   |       | 488                                                 |       |
|                                   |       |                                         |       |                       |       |                   |       |                     |       |                                                |       |
| Total                                  |       | $                                            | 9,511      |                       | $          | 41,485                 |       | $                        | (24,563    | )                                                   | $          | (2,449 | ) | $ | 23,984 |   |

 

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Themajority of the remaining cash expenditures related to the 2009 and 2008Restructuring Plans are expected to be paid in 2010. The remaining liabilitiesrelated to lease obligations are expected to be settled over the remaininglease term. The Company expects to incur additional restructuring charges in thefourth quarter of 2010 as it continues to execute the 2009 and 2008Restructuring Plans.

 

**NOTE 10 - COMMITMENTS AND CONTINGENCIES**

 

***Leases***

 

The Company leases certain facilities undernoncancelable operating leases that expire at various dates through 2016.  In connection with the Sale LeasebackAgreement, the Company entered into a lease with respect to the leaseback of aportion of the Hangzhou facility, see Note 7. The leaseback commenced on June 1, 2010 and the contractualobligations related to the Hangzhou facility lease are included in the tablebelow. Future minimum lease payments under all noncancelable operating leaseswith an initial term in excess of one year as of September 30, 2010 are asfollows:

 

| **Twelve months ending September 30:** | ** ** | **Amount**              | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                 | ** ** | **(in thousands)** | ** ** |
| 2011                                                       |       | $                       | 16,105     |   |
| 2012                                                       |       | 14,459                  |       |
| 2013                                                       |       | 14,671                  |       |
| 2014                                                       |       | 14,127                  |       |
| 2015                                                       |       | 14,500                  |       |
| Thereafter                                                 |       | 3,752                   |       |
| Total                                                      |       | $                       | 77,614     |   |

 

***Third Party Commissions***

 

The Company records accruals for commissions payableto third parties in the normal course of business. Such commissions arerecorded based on the terms of the contracts between the Company and the thirdparties and paid pursuant to such contracts. Consistent with the Company’saccounting policies, these commissions are recorded as cost of net sales in theperiod in which the liability is incurred. As of September 30, 2010, theCompany had approximately $0.5 million of such accrued commissions. Managementhas performed, and continues to perform, follow-up procedures with respect tothese accrued commissions. Upon completion of such follow-up procedures, if theaccrued commissions have not been claimed and the statute of limitations, ifany, has expired, the Company reverses such accruals. Such reversals arerecorded in the Statement of Operations during the period managementdetermines that such accruals are no longer necessary. With the assistance ofits China counsel, the Company concluded that for certain of these accruedcommissions the statute of limitations had expired in August 2010, two yearsafter formal communication was sent to these agents. During the three and ninemonths ended September 30, 2010 approximately $5.8 and $6.0 million,respectively, were released to cost of net sales as a result of expiration ofstatute of limitations. During the three and nine months ended September 30,2009, approximately $0.7 million and $0.8 million, respectively, were releasedto cost of net sales as a result of expiration of statute of limitations.

 

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***India Department of Telecommunication Security and Supply ChainStandards***

 

Recentchanges in India require equipment manufacturers to satisfy certain securityand supply chain standards to the satisfaction of Indian authorities. TheCompany entered into such agreements with several customers in India whichestablish detailed security and supply chain standards covering productssupplied to telecommunication customers. These agreements contain significant penalty clauses in the event asecurity breach is detected related to product supplied by the Company.  Management is unable to estimate thelikelihood or the financial impact of any such potential security breach onthe Company’s financial position, results of operations, or cash flows. TheCompany is currently assessing the potential impact these agreements may haveon the timing of revenue recognition.

 

***Litigation***

 

*Securities Class Action Litigation*

 

Beginningin October 2004, several shareholder class action lawsuits allegingfederal securities violations were filed against the Company and variousofficers and directors of the Company. The actions have been consolidated inUnited States District Court for the Northern District of California under thecaption *In re UTStarcom, Inc.Securities Litigation*, Master File No. C-04-4908-JW (PVT). Thelead plaintiffs in the case filed a First Amended Consolidated Complaint onJuly 26, 2005. The First Amended Complaint alleged violations of theSecurities Exchange Act of 1934, and was brought on behalf of a putative classof shareholders who purchased the Company’s stock after April 16, 2003 andbefore September 20, 2004. On April 13, 2006, the lead plaintiffsfiled a Second Amended Complaint adding new allegations and extending the endof the class period to October 6, 2005. In addition to the Companydefendants, the plaintiffs are also suing Softbank. Plaintiffs’ complaint seeksrecovery of damages in an unspecified amount.

 

OnJune 2, 2006, the Company and the individual defendants filed a motion todismiss the Second Amended Complaint. On March 21, 2007, the Court granteddefendants’ motion and dismissed plaintiffs’ Second Amended Complaint. TheCourt granted plaintiffs leave to file a Third Amended Complaint, whichplaintiffs filed on May 25, 2007. On July 13, 2007, the Company andthe individual defendants filed a motion to dismiss and a motion to strike theThird Amended Complaint. On March 14, 2008, the Court granted defendants’motion and dismissed plaintiffs’ Third Amended Complaint. The Court grantedplaintiffs leave to file a Fourth Amended Complaint, which plaintiffsfiled on May 14, 2008. On June 13, 2008, consistent with the Court’sMarch 14, 2008 dismissal order, the Company and the individual defendantsfiled objections to the form and content of the Fourth Amended Complaint. OnJuly 24, 2008, the Court overruled the objections. On September 8,2008, the Company and the individual defendants filed a motion to dismiss and amotion to strike certain allegations from the Fourth Amended Complaint. OnMarch 27, 2009, the Court denied defendants’ motion to dismiss and granteddefendants’ motion to strike.

 

Plaintiffs,the Company and the individual defendants have signed and filed a stipulationof settlement providing for the settlement of the case. Defendant Softbank isnot a party to the settlement. Under the terms of the settlement, the Company’sand individual defendants’ insurers would pay the full amount of thesettlement. On May 13, 2010, the Court granted preliminary approval of thesettlement, and on August 31, 2010, the Court granted final approval ofthe settlement. On October 8, 2010, plaintiffs and Defendant Softbankfiled a motion for preliminary approval of a separate settlement betweenplaintiffs and Defendant Softbank.  Thereis no assurance that this settlement will receive court approval.  If it does not, we continue to incur costswith regard to discovery in connection with the litigation between plaintiffsand Defendant Softbank.  Accordingly, theCompany is unable at this time to estimate the effects of this lawsuit on theCompany’s financial position, results of operations, or cash flows.

 

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*Shareholder Derivative Litigation*

 

OnNovember 17, 2006, a shareholder derivative complaint captioned *Ernesto Espinoza v. Ying Wu et al.*, CaseNo. RG06298775, was filed against certain of the Company’s former officersand current officers and directors in the Superior Court of the County ofAlameda, California. The complaint alleges that the individual defendants,among other things, breached their duties, were unjustly enriched, and violatedthe California Corporations Code in connection with the timing of stock optiongrants. The complaint names the Company as a nominal defendant and seeksunspecified monetary damages against the individual defendants and variousforms of injunctive relief. On February 2, 2007, the Company and theindividual defendants filed demurrers against the complaint. On April 11,2007, the Court sustained the individual defendants’ demurrer, overruled theCompany’s demurrer, ordered the plaintiff to file an amended complaint, andordered the Company to answer the original complaint. The plaintiff filed anamended complaint and the Company has filed an answer to the amended complaint.On August 21, 2007, the individual defendants filed demurrers against theamended complaint. The Court sustained the individual defendants’ demurrers andordered the plaintiff to file a second amended complaint. OnSeptember 26, 2008, plaintiff filed his second amended complaint. OnNovember 21, 2008, the Company and the individual defendants fileddemurrers against the second amended complaint. On February 27, 2009, theCourt sustained the Company’s demurrer and ordered the plaintiff to file athird amended complaint. On March 20, 2009, plaintiff filed his third amendedcomplaint. On May 5, 2009, the Company and the individual defendants fileddemurrers against the third amended complaint. On August 11, 2009, theCourt sustained the Company’s demurrer without leave to amend. OnOctober 13, 2009, plaintiffs filed a notice of appeal.

 

Theparties have signed a binding Memorandum of Understanding providing for thesettlement of the case. The settlement requires completion of final settlementdocumentation. The settlement is contingent on approval by the court. Under theterms of the settlement, the individual defendants’ insurer would pay the fullamount of the monetary portion of the settlement. On April 15, 2010,plaintiff filed a Request for Dismissal without prejudice with the Court ofAppeals. Pursuant to the Request, the appeal may be reinstated if the SuperiorCourt does not grant preliminary or final approval of the settlement. There isno assurance that the settlement will receive court approval. Accordingly, theCompany is unable at this time to estimate the effects of this lawsuit on theCompany’s financial position, results of operations, or cash flows.

 

*IPO Allocation*

 

On October 31, 2001, acomplaint was filed in United States District Court for the Southern Districtof New York against the Company, some of the Company’s directors and officersand various underwriters for the Company’s initial public offering.Substantially similar actions were filed concerning the initial publicofferings for more than 300 different issuers, and the cases were coordinated as*In re Initial Public Offerings SecuritiesLitigation*, Civil Action No. 01-CV-9604. Plaintiffs allegeviolations of the Securities Act of 1933 and the Securities Exchange Act of1934 through undisclosed improper underwriting practices concerning the allocationof IPO shares in exchange for excessive brokerage commissions, agreements topurchase shares at higher prices in the aftermarket and misleading analystreports. Plaintiffs seek unspecified damages on behalf of a purported class ofpurchasers of the Company’s common stock between March 2, 2000 andDecember 6, 2000. On February 19, 2003, the Court granted in part anddenied in part a motion to dismiss the claims brought by defendants,including the Company. The order dismissed all claims against the Companyexcept for a claim brought under Section 11 of the Securities Act of 1933,which alleges that the registration statement filed in accordance with the IPOwas misleading.

 

The parties have reached aglobal settlement of the litigation. Under the settlement the insurers will paythe full amount of the settlement share allocated to the Company, and theCompany will bear no financial liability. The Company and other defendants,will receive complete dismissals from the case. On October 5, 2009, the Courtentered an Opinion and Order granting final approval of the settlement. Certainobjectors have filed appeals. If for any reason the settlement does not becomeeffective, the Company believes it has meritorious defenses to the claims andintends to defend the action vigorously.

 

*Other Litigation*

 

TheCompany is a party to other litigation matters and claims that are normal inthe course of operations, and while the results of such litigation matters andclaims cannot be predicted with certainty, management of the Company believesthat the final outcome of such matters will not have a material adverse impacton the Company’s financial position, results of operations or cash flows.

 

***Letters of credit***

 

TheCompany issues standby letters of credit primarily to support internationalsales activities outside of China and in support of purchase commitments. Whenthe Company submits a bid for a sale, often the potential customer will requirethat the Company issue a bid bond or a standby letter of credit to demonstrateits commitment through the bid process. In addition, the Company may berequired to issue standby letters of credit as guarantees for advance customerpayments upon contract signing or performance guarantees. The standby lettersof credit usually expire without being drawn by the beneficiary thereof.Finally, the Company may issue commercial letters of credit in support ofpurchase commitments. At September 30, 2010, the Company had short-termrestricted cash of $22.4 million, and long-term restricted cash of $7.6 millionincluded in other long-term assets. The restricted cash amounts primarilycollateralize the Company’s outstanding letters of credit approximating $23.3million at September 30, 2010.

 

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**NOTE 11 — COMMON STOCK PURCHASE AND OPTION TO PURCHASEADDITIONAL SHARES**

 

OnFebruary 1, 2010, the Company entered into Stock Purchase Agreements withBeijing E-town International Investment and Development Co., Ltd. (“BEIID”),and two unrelated investment funds, Elite Noble Limited and Shah CapitalOpportunity Fund LP, which included a proposed investment of $48.5 million inthe Company’s common stock. The Stock Purchase Agreements were subsequentlyamended on May 4, 2010, June 4, 2010 and July 7, 2010,respectively.

 

OnSeptember 7, 2010, the Company and the investors entered into a fourthamendment to each of the Stock Purchase Agreements (“Fourth Amendments”) to reducethe per share purchase price and to make certain adjustment to the number ofshares sold under the agreements.  Under the terms of the FourthAmendments, the Company and the investors agreed to reduce the purchase pricefrom $2.20 per share to $2.027 per share and adjust the number of shares soldto each of the investors.  The Fourth Amendments also provided an optionto Elite Noble Limited to purchase up to an additional 3,972,251 shares throughNovember 8, 2010 for approximately$8.1 million based on a stated exercise price of $2.027per share if the purchase takes place on or prior to October 7, 2010 and$2.047 per share if the purchase takes place between October 8, 2010 andNovember 8, 2010. On September 7, 2010, the Company completed thetransaction and issued an aggregate 18,073,202 shares of its common stock andthe option to purchase an additional 3,972,251 shares for cash proceeds, net ofissuance costs, of $34.6 million. Net cash proceeds were allocated to thecommon stock issued and the option to purchase additional shares based on theirrelative fair value at the date of issuance, resulting in $34.1 million of netcash proceeds allocated to the common stock issued and $0.5 million of net cashproceeds allocated to the option to purchase additional shares.

 

Thefair value of the option to purchase the additional 3,972,251 shares wasestimated to be $0.5 million at the date of issuance based on the Black-Scholesoption pricing model using a risk-free interest rate of 0.16%, volatility ofapproximately 55%, the contractual life of 0.2 years and zero dividend rate.The net cash proceeds allocated to the option to purchase additional shareswere recorded as additional paid in capital. The option was outstanding at September 30,2010.

 

**NOTE 12 — STOCK INCENTIVE PLAN**

 

Duringthe nine months ended September 30, 2010, the Company granted equityawards primarily consisting of restricted stock and restricted stock units (“RSUs”),and to a much lesser extent, option awards. Such awards generally vest over aperiod of one to four years from the date of grant. Restricted stock has thevoting rights of common stock and the shares underlying restricted stock areissued and outstanding. There were 555,391 option awards during the threemonths ended September 30, 2010.

 

InFebruary 2008, the Compensation Committee granted 1,073,333performance-based awards to certain senior executive officers. During the thirdquarter of 2008, 233,333 of these contingently issuable shares were forfeitedas a result of employee terminations. On October 6, 2008, the performancerequirements with respect to 60,000 of these contingently issuable shares wereeliminated, these restricted stock units have a fair value of $2.69 per share,which equals the closing price of the Company’s common stock on the NASDAQStock Market on the measurement date of October 6, 2008. OnFebruary 18, 2009, the Committee determined, based on the Company’s andeach executive officer’s level of performance during the Company’s 2008 fiscalyear, that an additional 367,500 shares underlying the previously grantedperformance-based restricted stock units had been earned, each of theseperformance-based restricted stock units has a fair value of $1.27 per share, whichequals the closing price of the Company’s common stock on the NASDAQ StockMarket on the measurement date of February 18, 2009. These restrictedstock units vested 50% on February 27, 2009 and 50% vested onFebruary 26, 2010.

 

InFebruary 2009, the Compensation Committee also granted to senior executiveofficers 313,293 restricted stock units with a four-year vesting and anadditional 626,586 performance-based awards, subject to the attainment of goalsdetermined by the Compensation Committee. The Company may be subject tovariable levels of expense related primarily to the varying levels ofperformance, as well as for fluctuations in the Company’s stock price as theseawards are “marked to market” periodically until the earlier of i) the date ofthe Compensation Committee’s determination on performance or ii) the date theywere deemed fully vested as a result of involuntary termination. Of the 626,586performance-based awards granted in February 2009, 401,859 awards weredeemed fully vested during fiscal 2009 as a result of involuntary terminations,prior to the annual Compensation Committee’s evaluation of performance. At itsmeeting on February 18, 2010, the Compensation Committee evaluated theperformance against established objectives of the remaining 224,727performance-based awards and determined 148,769 RSUs were earned.

 

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InFebruary 2010, the Compensation Committee decided no annual grants ofstock-based awards would be made to existing senior executives for the 2010year in light of the Company’s previously announced planned changes inmanagement.

 

Toreduce the Company’s long term cost structure and manage shareholder dilution,the Company has elected to terminate the ESPP program effective May 15,2009. The cancellation has been accounted for as a settlement of shares for noconsideration. This resulted in an immediate expense recognition in the first quarterof 2009 of $1.2 million associated with the unrecognized compensation forcanceled purchase periods of the 24-month offering.

 

Duringthe second quarter of 2009, an adjustment was made to increase the estimatedforfeiture rate for equity awards of employees that are being included in the2009 Restructuring Plan as the awards are not expected to ultimately vest.  The resulting net effect of the forfeiturerate adjustment was a decrease to the Company’s stock-based compensationexpense for the nine months ended September 30, 2009 by approximately $0.4million.

 

Thetotal stock-based compensation expense, including the ESPP expense describedabove, recognized in the condensed consolidated statement of operations for thethree months and nine months ended September 30, 2010 and 2009 was asfollows:

 
| ** **                          | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                          | ** ** | **(in thousands)**                                  | ** ** |
| Cost of net sales                   |       | $                                                        | 42         |                                                    | $          | 101 |   | $ | 135 |   | $ | 592 |   |
| Selling, general and administrative |       | 901                                                      |       | 1,516                                                   |       | 3,381 |   | 5,572 |   |
| Research and development            |       | 202                                                      |       | 237                                                     |       | 563 |   | 1,321 |   |
| Restructuring                       |       | 439                                                      |       | 1,153                                                   |       | 2,052 |   | 1,949 |   |
| Total                               |       | $                                                        | 1,584      |                                                    | $          | 3,007 |   | $ | 6,131 |   | $ | 9,434 |   |

 

Optionactivity as of September 30, 2010 and changes during the nine months endedSeptember 30, 2010 were as follows:

 
| ** **                                   | ** ** | **Number of shares  outstanding** | ** ** | **Weighted  average exercise  price** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
|                                         |       | **(in thousands)**                     |       |                                       |       |   |
| Options outstanding, December 31, 2009  |       | 5,750                                       |       | $                                          | 8.98       |   |
| Options granted                              |       | 655                                         |       | 2.17                                       |       |
| Options exercised                            |       | (2                                          | )          | 2.82                                       |       |
| Options forfeited or expired                 |       | (1,945                                      | )          | 15.77                                      |       |
| Options outstanding, September 30, 2010 |       | 4,458                                       |       | $                                          | 5.02       |   |

 

Nonvestedrestricted stock and restricted stock units as of September 30, 2010, andchanges during the nine months ended September 30, 2010, were as follows:

 
| ** **                                 | ** ** | **Shares**              | ** ** | **Weighted average  grant date fair value** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                 | ** ** | **(in thousands)** | ** ** | ** **                                                      | ** ** |
| Nonvested at December 31, 2009        |       | 4,030                   |       | $                                                               | 2.38       |   |
| Granted                                    |       | 1,479                   |       | $                                                               | 2.25       |   |
| Vested                                     |       | (2,634                  | )          | $                                                               | 2.75       |   |
| Forfeited                                  |       | (564                    | )          | $                                                               | 2.14       |   |
| Total nonvested at September 30, 2010 |       | 2,311                   |       | $                                                               | 1.94       |   |

 

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AtSeptember 30, 2010, there was approximately $4.0 million of totalunrecognized compensation cost, related to non-vested stock options, restrictedstock and restricted stock units, as measured, which the Company expects torecognize over a weighted-average period of 2.3 years. For additionalinformation regarding the Company’s stock-based compensation plans, see theCompany’s Annual Report on Form 10-K for the year ended December 31,2009.

 

**NOTE 13 - INCOME TAXES**

 

Asof December 31, 2009, the Company had gross unrecognized tax benefits ofapproximately $90.6 million and had certain deferred tax assets and thefederal tax benefit of state income tax items totaling $77.8 million. Ifrecognized, the portion of gross unrecognized tax benefits that would decreasethe provision for income taxes and decrease the Company’s net loss isapproximately $12.8 million.

 

Asof September 30, 2010, the Company had gross unrecognized tax benefits ofapproximately $92.9 million and had certain deferred tax assets and thefederal tax benefit of state income tax items totaling $78.5 million. Ifrecognized, the portion of gross unrecognized tax benefits that would decreasethe provision for income taxes and decrease the Company’s net loss isapproximately $14.4 million.

 

TheCompany recognizes interest expense and penalties related to the aboveunrecognized tax benefits within income tax expense. The Company had accruedinterest and penalties of approximately $3.1 million as of December 31,2009 and approximately $3.4 million as of September 30, 2010.

 

TheCompany is subject to taxation in the U.S. federal jurisdiction andvarious U.S. state and foreign jurisdictions. The Company is under auditby the taxing authorities in China on a recurring basis. The materialjurisdictions that the Company is subject to examination are in theUnited States and China. The Company’s tax years for 1999 through 2009 arestill open for examination in China. The Company’s tax years for 2006 through2009 are still open for examination in the United States. The Companybelieves that it is reasonably possible that the amount of gross unrecognizedtax benefits related to the resolution of income tax matters could be reducedby approximately $1.0 million during the next 12 months as income tax auditsare settled and statute of limitations expire. The portion of the $1.0 millionof gross unrecognized tax benefits that would decrease the provision for incometaxes and increase the Company’s net income is approximately $0.7 million.

 

FASBASC 740-10 establishes criteria for recognizing or continuing to recognize onlymore-likely-than-not tax positions, which may result in income tax expensevolatility in future periods. While the Company believes that it has adequatelyprovided for all tax positions, amounts asserted by taxing authorities could begreater than the Company’s accrued position. Accordingly, additional provisionson income tax related matters could be recorded in the future as revisedestimates are made or the underlying matters are settled or otherwise resolved.

 

Inestablishing its deferred income tax assets and liabilities, the Company makesjudgments and interpretations based on the enacted tax laws and published taxguidance applicable to its operations. The Company records deferred tax assetsand liabilities and evaluates the need for valuation allowances to reduce thedeferred tax assets to realizable amounts. The likelihood of a material changein the Company’s expected realization of these assets is dependent on futuretaxable income and its ability to use foreign tax credit carryforwardsand carrybacks.

 

Incometax expense was $1.4 million for the three months ended September 30, 2010compared to income tax benefit of $0.3 million for the three months endedSeptember 30, 2009.  Income taxbenefit of $0.3 million for the three months ended September 30, 2009 wasmainly due to a one-time tax benefit related to the change in India withholdingtaxes. Income tax expense was $3.2 million for the nine months ended September 30,2010 compared to $6.2 million for the nine months ended September 30,2009. The decrease in income tax expense in the nine months endedSeptember 30, 2010 compared with nine months ended September 30, 2009was primarily due to the decreased ordinary income in jurisdictions where theCompany has been profitable and a one-time tax expense of $1.4 million in thesecond quarter of 2009 related to establishing of valuation allowance on netdeferred tax assets in Korea.

 

For2010 and 2009, the Company has not provided any tax benefit on any forecastedlosses incurred and tax credits generated in the United States and othercountries, because management believes that it is more likely than not that thetax benefit associated with these losses will not be realized. Also, for 2010and 2009, the Company continues to accrue tax expense in jurisdictions wherethe Company has been historically profitable. Estimates of the annual effectivetax rate at the end of the interim periods are based on evaluations of possiblefuture events and transactions and may be subject to subsequent refinement orrevision.

 

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**NOTE 14 - OTHER INCOME (EXPENSE), NET**

 

Otherincome (expense), net for the three and nine months ended September 30,2010 and 2009, respectively were comprised of the following:

 
| ** **                                            | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                            | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                            | ** ** | **(in thousands)**                                  | ** ** |
| Other-than-temporary impairment of equity  investment |       | $                                                        | —     |                                                    | $          | (1,719 | ) | $ | — |   | $ | (5,517 | ) |
| Foreign exchange gains (losses)                       |       | 6,908                                                    |       | (11                                                     | )          | 6,057 |   | 1,734 |   |
| Settlement with MRV Communications (1)                |       | —                                                   |       | —                                                  |       | 481 |   | — |   |
| Other                                                 |       | 59                                                       |       | 174                                                     |       | 529 |   | 442 |   |
| Total                                                 |       | $                                                        | 6,967      |                                                    | $          | (1,556 | ) | $ | 7,067 |   | $ | (3,341 | ) |

 

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(1)          Previously, the Company held an 8% ownershipinterest in Fiberxon, which was acquired by MRV Communications (“MRV”) in 2007.In connection with the acquisition, Fiberxon shareholders received cash andstock as well as the right to potential deferred consideration. InDecember 2009, MRV entered into a settlement agreement for dismissal oflegal proceedings between MRV and the former shareholders of Fiberxon regardingthe amount of contingent consideration owed related to its acquisition.Proceeds received in the first quarter of 2010 represented the Company’sproportionate share of the settlement amounts.

 

**NOTE 15 - SEGMENT REPORTING**

 

Inthe fourth quarter of 2009, the Company substantially completed the wind-downof its handset business. Except for sales relating to inventory clearing, theCompany does not expect any significant handset revenue in 2010. Beginning onJanuary 1, 2010, the Company integrated its Services Segment into itsMultimedia Communications and Broadband Infrastructure segments based onproducts for which services are performed. Effective January 1, 2010, thenew reporting segments are as follows:

 

·                  MultimediaCommunications—Focused on development and market opportunities in IPTVsolutions and Wireless infrastructure technologies, including related servicesrevenue.

 

·                  BroadbandInfrastructure—Focused on our world class portfolio of broadband products,including related services revenue.

 

·                  Handsets—Focusedon mobile phone business including PAS and CDMA handset market, as well as datacards markets. Handset sales to PCD LLC, which commenced after theJuly 1, 2008 sale of PCD, are included in this segment.

 

TheCompany’s chief operating decision makers make financial decisions based oninformation it receives from its internal management system and currentlyevaluates the operating performance of and allocates resources to the reportingsegments based on segment revenue and gross profit. Cost of sales and directexpenses in relation to production are assigned to the reporting segments. Theaccounting policies used in measuring segment assets and operating performanceare the same as those used at the consolidated level.

 

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Summarizedbelow are the Company’s segment net sales, gross (loss) profit and segmentmargin for the three and nine months ended September 30, 2010 and 2009based on the current reporting segment structure. The Company has reclassifiedits previously reported segment information for the three and nine months endedSeptember 30, 2009 to conform to the current segment presentation.

 
| ** **                  | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                  | ** ** | **2010**                                                 | ** ** | **% of net  sales**                           | ** ** | **2009** | ** ** | **% of net  sales** | ** ** | **2010** | ** ** | **% of net  sales** | ** ** | **2009** | ** ** | **% of net  sales** | ** ** |
| ** **                  | ** ** | **(in thousands, except percentages)**    | ** ** |
| ***Net Sales by  Segment*** |       |                                                     |       |                                                    |       |   |   |   |   |   | *** *** | *** *** | *** *** | *** *** |   |   |   |
| Multimedia Communications   |       | $                                                        | 39,500     |                                                    | 64         | % | $ | 30,044 |   | 43 | % | $ | 128,811 |   | 60 | % | $ | 120,520 |   | 45 | % |
| Broadband Infrastructure    |       | 21,068                                                   |       | 35                                                      | %          | 24,847 |   | 35 | % | 80,303 |   | 37 | % | 64,629 |   | 24 | % |
| Handsets                    |       | 826                                                      |       | 1                                                       | %          | 15,613 |   | 22 | % | 6,292 |   | 3 | % | 84,858 |   | 31 | % |
|                        |       | $                                                        | 61,394     |                                                    | 100        | % | $ | 70,504 |   | 100 | % | $ | 215,406 |   | 100 | % | $ | 270,007 |   | 100 | % |

 
| ** **                     | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                     | ** ** | **2010**                                                 | ** ** | **Gross  profit %**                                | ** ** | **2009** | ** ** | **Gross  profit %** | ** ** | **2010** | ** ** | **Gross  profit %** | ** ** | **2009** | ** ** | **Gross  profit %** | ** ** |
| ** **                     | ** ** | **(in thousands, except percentages)**    | ** ** |
| ***Gross profit by  Segment*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Multimedia Communications      |       | $                                                        | 14,055     |                                                    | 36         | % | $ | 12,884 |   | 43 | % | $ | 42,626 |   | 33 | % | $ | 41,587 |   | 35 | % |
| Broadband Infrastructure       |       | (1,581                                                   | )          | (8                                                      | )%         | 7,983 |   | 32 | % | 16,264 |   | 20 | % | 13,013 |   | 20 | % |
| Handsets                       |       | (381                                                     | )          | (46                                                     | )%         | 3,322 |   | 21 | % | 3,284 |   | 52 | % | (24,597 | ) | (29 | )% |
|                           |       | $                                                        | 12,093     |                                                    | 20         | % | $ | 24,189 |   | 34 | % | $ | 62,174 |   | 29 | % | $ | 30,003 |   | 11 | % |

 
| ** **                               | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                               | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                               | ** ** | **(in thousands)**                                  | ** ** |
| ***Segment Margin  and Operating Loss*** |       |                                                     |       |                                                    |       |   |   |   |   |
| Multimedia Communications                |       | $                                                        | 5,958      |                                                    | $          | 3,218 |   | $ | 20,211 |   | $ | 9,152 |   |
| Broadband Infrastructure                 |       | (5,127                                                   | )          | 4,094                                                   |       | 6,381 |   | — |   |
| Handsets                                 |       | (731                                                     | )          | 470                                                     |       | 2,268 |   | (37,996 | ) |
| Total segment margin                     |       | 100                                                      |       | 7,782                                                   |       | 28,860 |   | (28,844 | ) |
| General and Corporate                    |       | (23,359                                                  | )          | (41,576                                                 | )          | (75,974 | ) | (149,243 | ) |
| Operating Loss                           |       | $                                                        | (23,259    | )                                                       | $          | (33,794 | ) | $ | (47,114 | ) | $ | (178,087 | ) |

 

Salesare attributed to a geographical area based upon the location of the customer.Sales data by geographical area are as follows:

 
| ** **                 | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                               | ** ** | **% of net**                                  | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                 | ** ** | **2010**                                                 | ** ** | **sales**                                               | ** ** | **2009** | ** ** | **sales** | ** ** | **2010** | ** ** | **sales** | ** ** | **2009** | ** ** | **sales** | ** ** |
| ** **                 | ** ** | **(in thousands, except percentages)**    | ** ** |
| ***Net Sales by  region*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| United States              |       | $                                                        | —     |                                                    | —     | % | $ | 10,664 |   | 15 | % | $ | 5,903 |   | 3 | % | $ | 53,654 |   | 20 | % |
| China                      |       | 37,162                                                   |       | 61                                                      | %          | 30,959 |   | 44 | % | 120,348 |   | 55 | % | 134,708 |   | 50 | % |
| Japan                      |       | 11,718                                                   |       | 19                                                      | %          | 5,051 |   | 7 | % | 33,951 |   | 16 | % | 18,093 |   | 7 | % |
| India                      |       | 8,093                                                    |       | 13                                                      | %          | 14,399 |   | 20 | % | 20,446 |   | 9 | % | 33,519 |   | 12 | % |
| Philippines                |       | 642                                                      |       | 1                                                       | %          | 4,631 |   | 7 | % | 16,316 |   | 8 | % | 7,528 |   | 3 | % |
| Other                      |       | 3,779                                                    |       | 6                                                       | %          | 4,800 |   | 7 | % | 18,442 |   | 9 | % | 22,505 |   | 8 | % |
| Net sales                  |       | $                                                        | 61,394     |                                                    | 100        | % | $ | 70,504 |   | 100 | % | $ | 215,406 |   | 100 | % | $ | 270,007 |   | 100 | % |

 

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Long-livedassets, consisting of property, plant and equipment, by geographical area areas follows:

 
| ** **              | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **2010**                | ** ** | **2009**              | ** ** |
| ** **              | ** ** | **(in thousands)** | ** ** |
| United States           |       | $                       | 85         |                  | $          | 170 |   |
| China                   |       | 4,111                   |       | 129,746               |       |
| Other                   |       | 614                     |       | 696                   |       |
| Total long-lived assets |       | $                       | 4,810      |                  | $          | 130,612 |   |

 

**NOTE 16 - CREDIT RISK AND CONCENTRATION**

 

AtSeptember 30, 2010, the Company’s accounts receivable balance includedamounts due from Philippine Long Distance Telephone Company and NEC Networks &System Integration Corp, representing approximately 19% and 15%, respectively,of the Company’s total accounts receivable, net of allowances for doubtfulaccounts. At December 31, 2009, the Company’s accounts receivable balanceincluded amounts due from China Telecom, JiangSu Branch representingapproximately 11% of the Company’s total accounts receivable, net of allowancesfor doubtful accounts.

 

Thefollowing customers accounted for 10% or more of the Company’s net sales:

 
| ** **              | ** ** | **For the three**         | ** ** | **For the nine** | ** ** |
|-------------------------|------------|-------------------------------------|------------|----------------------------|------------|
| ** **              | ** ** | **months ended**               | ** ** | **months ended**      | ** ** |
| ** **              | ** ** | **September 30,**              | ** ** | **September 30,**     | ** ** |
| ** **              | ** ** | **(% of net sales)** | ** ** |
| **2010**                | ** ** | ** **                          | ** ** | ** **                 | ** ** |
| Softbank and affiliates |       | 18                                  | %          | 14                         | %          |
|                    |       |                                |       |                       |       |
| **2009**                | ** ** | ** **                          | ** ** | ** **                 | ** ** |
| PCD LLC                 |       | 11                                  | %          | 16                         | %          |

 

Approximately56% and 33% of the Company’s net sales during the three months endedSeptember 30, 2010 and 2009, respectively, and approximately 51% and 31%of the Company’s net sales during the nine months ended September 30, 2010and 2009, respectively, were to entities affiliated with the government ofChina. Accounts receivable balances from these China government affiliatedentities or state owned enterprises were $39.5 million and $45.7 million as ofSeptember 30, 2010 and December 31, 2009, respectively. The Companyextends credit to its customers in China generally without requiringcollateral. With respect to global sales outside of China, the Company mayrequire letters of credit from its customers. The Company monitors its exposurefor credit losses and maintains allowances for doubtful accounts.

 

Approximately61% and 44% of the Company’s sales for the three months endedSeptember 30, 2010 and 2009, respectively, and approximately 55% and 50%of the Company’s net sales during the nine months ended September 30, 2010and 2009, respectively, were made in China. Accordingly, the political,economic and legal environment, as well as the general state of China’s economymay influence the Company’s business, financial condition and results ofoperations. The Company’s operations in China are subject to specialconsiderations and significant risks not typically associated with companies inthe United States. These include risks associated with, among others, thepolitical, economic and legal environments and foreign currency exchange. TheCompany’s results may be adversely affected by, among other things, changes inthe political, economic and social conditions in China, and by changes ingovernmental policies with respect to laws and regulations, changes in China’stelecommunications industry and regulatory rules and policies,anti-inflationary measures, currency conversion and remittance abroad, andrates and methods of taxation.

 

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**NOTE 17 - RELATED PARTY TRANSACTIONS**

 

*Softbank and affiliates*

 

TheCompany recognizes revenue with respect to sales of telecommunicationsequipment to affiliates of Softbank, a significant stockholder of the Company.Softbank offers ADSL coverage throughout Japan, which is marketed under thename “YAHOO! BB.” The Company supports Softbank’s fiber-to-the-home servicethrough sales of its carrier class GEPON product as well as its NetRingÔ product. Inaddition, the Company supports Softbank’s new internet protocol television (“IPTV”),through sales of its RollingStreamÔ product. During the threeand nine months ended September 30, 2010 and 2009, the Company recognizedrevenue and related cost of net sales for sales of telecommunications equipmentand services to affiliates of Softbank as follows:

 
| ** **        | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **        | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **        | ** ** | **(in thousands)**                                  | ** ** |
|              |       |                                                     |       |                                                    |       |   |   |   |   |
| Net sales         |       | $                                                        | 11,356     |                                                    | $          | 4,832 |   | $ | 32,868 |   | $ | 16,030 |   |
| Cost of net sales |       | 3,771                                                    |       | 2,552                                                   |       | 12,739 |   | 9,310 |   |
| Gross profit      |       | $                                                        | 7,585      |                                                    | $          | 2,280 |   | $ | 20,129 |   | $ | 6,720 |   |

 

Grossprofit as a percentage of net sales fluctuations are expected and generallyresult from changes in product mix. In the nine months ended September 30,2010, gross profit as a percentage of net sales also benefited approximately$2.4 million from the release of previously deferred revenue carve-out forpotential penalty and cancellation penalties as a result of completing theseobligations. Included in accounts receivable at September 30, 2010 andDecember 31, 2009 were $13.0 million and $5.5 million, respectively,related to these transactions.

 

Salesto Softbank include a three year service period and a penalty clause if productfailure rates exceed a certain level over a seven year period. As ofSeptember 30, 2010 and December 31, 2009, the Company’s customeradvance balance related to Softbank agreements was $0.2 million and $0.2million, respectively. The current deferred revenue balance related to Softbankwas $1.2 million and $1.4 million as of September 30, 2010 andDecember 31, 2009, respectively. As of September 30, 2010, theCompany’s noncurrent deferred revenue balance related to Softbank was $7.3million compared to $8.8 million as of December 31, 2009.

 

Asdiscussed in Note 6, the Company has a $1.1 million investment in SBI.Affiliates of Softbank have a controlling interest in SBI.

 

Asof September 30, 2010, Softbank beneficially owned approximately 10% ofthe Company’s outstanding stock.

 

**NOTE 18—VARIABLE INTEREST ENTITIES**

 

InOctober 2008, the Company made an investment in Turnstone EnvironmentTechnologies LLC (“TET”), a Delaware limited liability company formed forthe purpose of licensing and developing energy efficient renewable coolingsolutions for cell towers in the telecommunications industry. In exchange for5,180,788 Series A Preferred units representing approximately 22% of votinginterest in TET and 500,000 Series A Preferred warrants at anexercise price of $0.9265 per unit and with an expiration term of 5 years,the Company contributed $4.8 million in cash. The Company currently doesnot have any representation on TET’s board of directors nor the ability tocontrol the management and operation decisions of TET. The operations of TETare in the development stage and the entity is actively seeking additionalinvestors. The Company does not intend to and has no obligation to fund futurelosses or make additional contributions other than its initial investment. Asof December 31, 2009 and 2008, TET was in effect entirely funded by theCompany’s initial investment as the capital contributions of the other currentinvestors were not substantive. The Company determined that the venture was avariable interest entity and the Company was the primary beneficiary because itwas exposed to the majority of the variable interest entity’s expected losses.Therefore, the Company was required to consolidate TET’s financial statementsunder ASC 810-10-15, Variable Interest Entities**Subsections.Beginning January 1, 2009, the assets, liabilities and operating resultsof TET were consolidated into the Company’s balance sheet and statement of operations.TET had no revenues and $3.9 million in expenses for the year endedDecember 31, 2009, of which $3.1 million relates to amortization of anacquired exclusive license to utilize solar cooling technology. The Companyinitially determined the appropriate amortization period for the exclusivelicense was to match the estimated revenue generation period from sale ofproducts utilizing the licensed technology. In the third quarter of 2009, as aresult of the delay in revenue generation, the Company changed its estimate toa systematic and rational allocation of straight-line amortization expensebased on the term of the technology license. TET’s operations are notconsidered to be integral to the Company’s major operating activities. As such,all income and expenses from TET’s operations, which are includable in theCompany’s income statement as a result of the application of ASC 810-10-15,Variable Interest Entities**Subsections,have been classified within operating expense.

 

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In the fourth quarter of2009, the Company evaluated several fourth quarter events, including thecontinued unsuccessful efforts of TET to secure additional funding; thecontinued unsuccessful efforts of TET to locate a suitable local manufacturingpartner, TET’s continued need to amend and extend payment due dates of theacquired exclusive license to utilize solar cooling technology and the departureof a key employee of TET. The Company determined that the combined effect ofthese events, as well as others, was a triggering event for an impairmentanalysis of TET’s long-lived assets. The Company furthered determined that theestimated cash flows from TET were not sufficient to recover the carrying valueof TET’s net assets. As a result, the Company recorded a $0.9 millionimpairment charge, included within operating expense, equal to its initial costof investment of $4.8 million less the cumulative absorbed losses to date. Asof December 31, 2009, the effect of consolidating TET resulted in animmaterial impact on the consolidated balance sheet.

 

In June 2009, the FASBissued authoritative guidance which revised the approach to identifying primarybeneficiaries from a quantitative-based risks-and rewards calculation to aqualitative approach when assessing whether an entity has a controllingfinancial interest in a variable interest entity. This analysis identifies theprimary beneficiary of a variable interest entity as one with the power todirect the activities of a variable interest entity that most significantlyimpact the entity’s economic performance and the obligation to absorb losses ofthe entity that could potentially be significant to the variable interest. TheCompany adopted this new guidance in the first quarter of fiscal year 2010.Under the new guidance, the Company concluded that it does not have the powerto direct the activities of TET that most significantly impact the entity’seconomic performance, and therefore, is not TET’s primary beneficiary whichwould require consolidation. The Company further concluded that under the newguidance it would have accounted for its initial investment under the costmethod. The new guidance also requires an enterprise upon initial adoption todetermine the carrying amount of an investment in an entity that is no longerconsolidated, as if it always had applied the provisions of the new guidance.Because under either the consolidation model or the cost method, thebalance(s) of the assets/liabilities (investment) would be zero in thefinancial statements of the Company at December 31, 2009 orJanuary 1, 2010, respectively, the adoption of the new guidance in thefirst quarter of 2010 has no financial statement impact to the Company.

 

**NOTE 19—SUBSEQUENT EVENTS**

 

OnOctober 16, 2010, the Company entered into an Ordinary Shares Purchasewith Stage Smart Limited (“Stage Smart”) and Smart Frontier Holdings Limited (“SmartFrontier”), the sole shareholder of Stage Smart.  Pursuant to the OrdinaryShares Purchase Agreement, the Company agreed to purchase from Smart Frontier5,100,000 ordinary shares of Stage Smart held by Smart Frontier (the “Purchase Shares”)for an aggregate purchase price of $10.0 million.  The Purchased Sharesconstitute 51% of the total shares of Stage Smart currently held by SmartFrontier. The purchase price for the Purchased Shares will be paid in the formof the number of shares of the Company’s common stock calculated by dividing$10.0 million by the average closing price per share of the Company’s commonstock quoted on the NASDAQ stock market for the thirty day period immediatelypreceding the date of closing of the transaction subject to customary closingconditions. Concurrent with entering into the Ordinary Shares PurchaseAgreement, the Company also entered into a Series A Preference SharesPurchase Agreement with Stage Smart and its affiliated entity, its wholly ownedsubsidiaries, and Smart Frontier.  Pursuant to the Series APreference Shares Purchase Agreement, the Company agreed to purchase from StageSmart 9,600,000 Series A Preference Shares of Stage Smart at a price of$2.08333 per share, for an aggregate consideration of $20.0 million. Undercertain conditions, shares of Series A Preference Shares are convertibleinto ordinary shares on a 1:1 basis.

 

**ITEM 2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

**FORWARD-LOOKING STATEMENTS**

 

ThisQuarterly Report on Form 10-Q contains forward-looking statementsregarding future events and our future results that are subject to the safeharbors created under the Securities Act of 1933 and the Securities ExchangeAct of 1934. Forward-looking statements are based on current expectations,estimates, forecasts and projections about us, our future performance and theindustries in which we operate as well as on our management’s assumptions andbeliefs. Statements that contain words like “expects,” “anticipates,” “may,” “will,”“targets,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” orvariations of such words and similar expressions are forward-lookingstatements. In addition, any statements that refer to trends in our businesses,future financial results, and our liquidity and business plans areforward-looking statements. Readers are cautioned that these forward-lookingstatements are only predictions and are subject to risks and uncertainties,including those discussed in “Part II, Item 1A-Risk Factors” of thisForm 10-Q.  Therefore, actualresults may differ materially and adversely from those expressed in anyforward-looking statements. We do not guarantee future results, and actualresults, developments and business decisions may differ from those contemplatedby those forward-looking statements.  Weundertake no obligation to update these forward-looking statements to reflectevents or circumstances occurring after the date of this Form 10-Q.

 

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**EXECUTIVE SUMMARY**

 

Weare one of the leading global providers of Internet Protocol (“IP”)-basednetwork solutions including the integration and support services sold totelecommunications operators in both emerging and established markets aroundthe world. Our focus is to design and sell IP-based telecommunicationsinfrastructure products including our primary product suite of InternetProtocol TV (“IPTV”), and broadband solutions along with the ongoing servicesrelating to the installation, operation and maintenance of these products.Collectively our range of solutions is designed to expand and modernizetelecommunications networks through smooth network system integration, loweroperating costs and increased broadband access. We also provide the carrierswith increased revenue opportunities by enhancing their subscribers’ userexperience. The majority of our business is based in China, India andother Asia markets. We also continue to maintain a presence in selectivemarkets in Latin America and Europe.

 

Wedifferentiate ourselves with products designed to reduce network complexity,integrate high performance capabilities and allow a simple transition to nextgeneration networks. We design our products to facilitate cost-effective andefficient deployment, maintenance and upgrades.

 

Becauseour products are IP-based, our customers can more easily integrate our productswith other industry standard hardware and software. Additionally, we believe wecan introduce new features and enhancements that can be cost-effectively addedto our customers’ existing networks. IP-based devices can be changed orupgraded in modules, saving our customers the expense of replacing their entiresystem installation.

 

InOctober 2010, we announced several critical shifts in our businessstrategy, including an increased focus on the Chinese and Asian markets, thepursuit of telecom and cable network customers in parallel and using our expertisein building and operating technology and service platforms for IPTV andInternet TV to sell more end-to-end solutions to service providers.

 

**Overview of Our Third Quarter 2010**

 

·                  OnFebruary 1, 2010, we entered into agreements for a strategic relationshipwith Beijing E-town International Investment and Development Co., Ltd(“BEIID”) which included a proposed investment in the Company’s common stock by BEIID, and two unrelated investmentfunds, Elite Noble Limited and Shah Capital Opportunity Fund LP. Theseinvestment transactions closed in September 2010. Under the revised terms,we received cash of $34.6 million and issued approximately 18.1 million sharesof common stock and an option to purchase up to an additional 4.0 millionshares of common stock for approximately $8.1 million through November 8,2010.

 

·                  In the thirdquarter of 2010, we continued to execute on our strategy to focus on ourIP-based product and services offerings by divesting our China PDSN Assets andtransferring our EMEA operations.  Wealso received $0.7 million of contingent consideration related to our secondquarter 2010 divestiture of IP Messaging and US PDSN Assets. We recognized a$1.4 million gain on divestiture in the third quarter of 2010 as a result ofthese transactions.

 

·                  Net sales decreased by $9.1 million to $61.4 million during the three months endedSeptember 30, 2010 compared to the same period in 2009. The decrease wasprimarily due to the wind-down of our handset business which resulted in adecrease of $14.8 million in revenue. This decrease was partially offset by the$9.5 million increase in sales of Multimedia Communications segment.  The increase is due to acceleratedamortization of $23.2 million of PAS deferred product revenue offsetting thedecrease in revenue of all other major product lines of the Multimedia Communicationssegment.

 

·                  Gross profit was $12.1 million, or 20% of netsales in the third quarter of 2010 compared to $24.2 million, or 34% of netsales in the corresponding period of 2009. The gross margin from Broadband segment was reduced $9.6 millionprimarily due to an $8.5 million inventory reserve for MSAN and MSTP for twointernational customer contracts.  Thegross margin from Handset sales was reduced $3.7 million as a result of thewind-down of our handset business. The gross margin from MultimediaCommunications increased $1.2 million, benefiting $5.8 million from the impactof the release of accrued third party commissions as a result of expiration of statute of limitations and benefitingfrom the acceleration of PAS deferred product revenue amortization, partiallyoffset by reserve for unrecoverable output VAT and decreased gross margin inother major product lines.

 

·                  Selling, general andadministrative and research and development operating expenses decreased $12.9million during the three months ended September 30, 2010 compared to thesame period in 2009. The decrease was primarily as a result of lower costs as aresult of restructuring and other cost reduction initiatives, partially offsetby a $2.5 million reserve for prepaid expatriate income tax on foreign taxcredit which we deem not recoverable and a $1.9 million provision for doubtfulaccounts during the three months ended September 30, 2010 relating toaging receivables compared to $1.6 million recovery of doubtful accounts in thesame period of 2009.

 

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**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations isbased upon our Consolidated Condensed Financial Statements, which we haveprepared in accordance with U.S. generally accepted accounting principles. Thepreparation of these financial statements requires management to make estimatesand assumptions that affect the amounts reported in our consolidated financialstatements and accompanying notes. Estimates are based on historicalexperience, knowledge of economic and market factors and various otherassumptions that management believes to be reasonable under the circumstances.Actual results may differ from those estimates.

 

Ona regular basis we evaluate our estimates, assumptions and judgments and makechanges accordingly. An accounting policy is deemed to be critical if itrequires an accounting estimate to be made based on assumptions about mattersthat are highly uncertain at the time the estimate is made, if differentestimates reasonably could have been used, or if changes in the estimate thatare reasonably likely to occur could materially impact the financialstatements. We believe that the estimates, assumptions and judgments involvedin revenue recognition, receivables and allowances for doubtful accounts,accruals including third party commissions payable, restructuring liabilities,litigation and other contingencies, stock-based compensation, product warranty,variable interest entities, inventories, deferred costs, research anddevelopment and capitalized software development costs, income taxes, impairmentof intangible assets and long-lived assets, and valuation and impairment ofinvestments have the greatest potential impact on our condensed consolidatedfinancial statements, so we consider these to be our critical accountingpolicies. Management believes that there have been no significant changesduring the nine months ended September 30, 2010 to the items that wedisclosed as our critical accounting policies and estimates in Management’sDiscussion and Analysis of Financial Condition and Results of Operations in ourAnnual Report on Form 10-K for the year ended December 31, 2009.

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

Fora description of the new accounting standards that affect us, see Note 2of Notes to our Condensed Consolidated Financial Statements included underPart I, Item 1 of this Quarterly Report on Form 10-Q.

** **

**RESULTS OF OPERATIONS**

 

Inthe fourth quarter of 2009, we substantially completed the wind-down of ourhandset business. Except for sales relating to inventory clearing, we do notexpect any significant revenue from our handset segment in the remainder of2010. In addition, in order to optimize our resources and improve efficiency,beginning on January 1, 2010 we integrated our Services Segment into ourMultimedia Communications and Broadband Infrastructure segments based onproducts for which services are performed. Effective January 1, 2010, thenew reporting segments are as follows:

 

·                  MultimediaCommunications—Focused on development and market opportunities in IPTVsolutions and Wireless infrastructure technologies, including related servicesrevenue.

 

·                  BroadbandInfrastructure—Focused on our world class portfolio of broadband products,including related services revenue.

 

·                  Handsets—Focusedon mobile phone business including PAS and CDMA handset market, as well as datacards markets. Handset sales to PCD LLC, which commenced after theJuly 1, 2008 sale of PCD, are included in this segment.

 

Wehave reclassified our previously reported segment information for the three andnine months ended September 30, 2009 to conform to the current segmentpresentation.

 

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**NETSALES**

 
| ** **                  | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                  | ** ** | ** **                                               | ** ** | **% of net**                                  | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                  | ** ** | **2010**                                                 | ** ** | **sales**                                               | ** ** | **2009** | ** ** | **sales** | ** ** | **2010** | ** ** | **sales** | ** ** | **2009** | ** ** | **sales** | ** ** |
| ** **                  | ** ** | **(in thousands, except percentages)**    | ** ** |
| ***Net Sales by  Segment*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                        |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Multimedia Communications   |       | $                                                        | 39,500     |                                                    | 64         | % | $ | 30,044 |   | 43 | % | $ | 128,811 |   | 60 | % | $ | 120,520 |   | 45 | % |
| Broadband Infrastructure    |       | 21,068                                                   |       | 35                                                      | %          | 24,847 |   | 35 | % | 80,303 |   | 37 | % | 64,629 |   | 24 | % |
| Handsets                    |       | 826                                                      |       | 1                                                       | %          | 15,613 |   | 22 | % | 6,292 |   | 3 | % | 84,858 |   | 31 | % |
|                        |       | $                                                        | 61,394     |                                                    | 100        | % | $ | 70,504 |   | 100 | % | $ | 215,406 |   | 100 | % | $ | 270,007 |   | 100 | % |

 
| ** **                 | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                               | ** ** | **% of net**                                  | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                 | ** ** | **2010**                                                 | ** ** | **sales**                                               | ** ** | **2009** | ** ** | **sales** | ** ** | **2010** | ** ** | **sales** | ** ** | **2009** | ** ** | **sales** | ** ** |
| ** **                 | ** ** | **(in thousands, except percentages)**    | ** ** |
| ***Net Sales by  region*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| United States              |       | $                                                        | —     |                                                    | —     | % | $ | 10,664 |   | 15 | % | $ | 5,903 |   | 3 | % | $ | 53,654 |   | 20 | % |
| China                      |       | 37,162                                                   |       | 61                                                      | %          | 30,959 |   | 44 | % | 120,348 |   | 55 | % | 134,708 |   | 50 | % |
| Japan                      |       | 11,718                                                   |       | 19                                                      | %          | 5,051 |   | 7 | % | 33,951 |   | 16 | % | 18,093 |   | 7 | % |
| India                      |       | 8,093                                                    |       | 13                                                      | %          | 14,399 |   | 20 | % | 20,446 |   | 9 | % | 33,519 |   | 12 | % |
| Philippines                |       | 642                                                      |       | 1                                                       | %          | 4,631 |   | 7 | % | 16,316 |   | 8 | % | 7,528 |   | 3 | % |
| Other                      |       | 3,779                                                    |       | 6                                                       | %          | 4,800 |   | 7 | % | 18,442 |   | 9 | % | 22,505 |   | 8 | % |
| Net sales                  |       | $                                                        | 61,394     |                                                    | 100        | % | $ | 70,504 |   | 100 | % | $ | 215,406 |   | 100 | % | $ | 270,007 |   | 100 | % |

 

*Three months ended September 30, 2010 and 2009*

 

Netsales decreased by 13% to $61.4 million during the three months endedSeptember 30, 2010 compared to the same period in 2009.  The decrease was primarily due to thewind-down of our handset business which resulted in a decrease of $14.8 millionin revenue. Broadband Infrastructure segment net sales decreased $3.8 million,mainly driven by the decreased sales in MSAN product and service sales, whichwas partially offset by increased sales in TN product.  Multimedia Communications segment net saleswere $39.5 million for the three months ended September 30, 2010 ascompared to $30.0 million for the same period of 2009. The increase was mainlydue to the accelerated amortization of PAS deferred product revenue partiallyoffset by the decrease in revenue of all other major product lines of thesegment.

 

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*Nine months ended September 30, 2010 and 2009*

 

Netsales decreased by 20% to $215.4 million during the nine months endedSeptember 30, 2010 compared to the same period in 2009.  The decrease was primarily due to thewind-down of our handset business which resulted in a decrease of $78.6 millionin revenue. This decrease was partially offset by the $15.7 million increase insales of Broadband Infrastructure segment mainly due to $11.9 million MSANproduct revenue recognized from an international customer. MultimediaCommunications net sales were $128.8 million for the nine months endedSeptember 30, 2010 as compared to $120.5 million for the same period of2009, mainly due to the accelerated amortization of PAS deferred productrevenue partially offset by the decrease in revenue of all other major productlines of the segment.

 

Foradditional discussion, see the “Segment Reporting” section of this Item 2.

 

In2010 and beyond, we do not expect significant new contracts for our PAShandsets and infrastructure equipment. As of September 30, 2010, we haveapproximately $120.1 million of deferred revenue associated with PASinfrastructure sales to be recognized ratably over the expected period ofsupport through December 2011. We review assumptions regarding theestimated post contract support periods on a regular basis. Due to the Chinatelecommunication industry restructuring and launching of 3G services in China,the Ministry of Industry and Information Technology of China announced that PASservices in China will be phased out by January 1, 2012. In the fourthquarter of 2009, we determined the remaining expected period of support as 2years and hence deferred revenue associated with PAS infrastructure is beingrecognized ratably beginning in the fourth quarter of 2009 through the fourthquarter of 2011. As a result of this change, net sales and gross profit in thenine months ended September 30, 2010 were increased by approximately $38.0million and $13.4 million, respectively compared to the same periods in 2009.In both fiscal 2010 and 2011, total net sales and gross profit associated withthe amortization of all PAS-related deferred revenue will approximate $93million and $33 million, respectively.

 

Theeconomic uncertainty that we are operating in today could adversely impact ourbusiness. However, the majority of our business is based in China and India—twocountries that are still projected to have economic growth in 2010. Wecurrently offer and have initial market acceptance of our IPTV products inChina, India, Taiwan and other geographic regions. We believe that theIPTV market presents a meaningful growth opportunity in these regions as wellas other regions where we have targeted to expand our IPTV offerings. Ourgrowth in India, however, may be adversely impacted by recent changes in Indiarequiring all manufacturers to satisfy certain security and supply chainstandards to the satisfaction of Indian authorities. We are pursuingalternative long-term solutions and working with the carriers who use ourproducts to make sure we can satisfy these new requirements.

 

**GROSS (LOSS) PROFIT**

 
| ** **                                 | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                 | ** ** | **2010**                                                 | ** ** | **Gross  profit %**                                | ** ** | **2009** | ** ** | **Gross  profit %** | ** ** | **2010** | ** ** | **Gross  profit %** | ** ** | **2009** | ** ** | **Gross  profit %** | ** ** |
| ** **                                 | ** ** | **(in thousands, except percentages)**    | ** ** |
| **Gross profit by Segment** | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Multimedia Communications                  |       | $                                                        | 14,055     |                                                    | 36         | % | $ | 12,884 |   | 43 | % | $ | 42,626 |   | 33 | % | $ | 41,587 |   | 35 | % |
| Broadband Infrastructure                   |       | (1,581                                                   | )          | (8                                                      | )%         | 7,983 |   | 32 | % | 16,264 |   | 20 | % | 13,013 |   | 20 | % |
| Handsets                                   |       | (381                                                     | )          | (46                                                     | )%         | 3,322 |   | 21 | % | 3,284 |   | 52 | % | (24,597 | ) | (29 | )% |
|                                       |       | $                                                        | 12,093     |                                                    | 20         | % | $ | 24,189 |   | 34 | % | $ | 62,174 |   | 29 | % | $ | 30,003 |   | 11 | % |

 

Costof sales consists primarily of material and labor costs, including stock-basedcompensation, associated with manufacturing, assembly and testing of products,costs associated with installation and customer training, warranty costs, thirdparty commissions/fees to agents, inventory write-downs and overhead. Cost ofsales also includes import taxes and tariffs on components and assemblies. Somecomponents and materials used in our products are purchased from a singlesupplier or a limited group of suppliers and, in some cases, are subject toobtaining Chinese import permits and approvals. Our global program to outsourceour manufacturing operations is still in progress.

 

Ourgross profit has been affected by average selling prices, material costs,product mix, the impact of warranty charges and contract loss provisions aswell as inventory reserves and release of deferred revenues and related costpertaining to prior years. Our gross profit, as a percentage of net sales,varies among our product families. We expect that our overall gross profit, asa percentage of net sales, will fluctuate in the future as a result of shiftsin product mix, stage of product life cycle, anticipated decreases in averageselling prices and our ability to reduce cost of sales.

 

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*Three months ended September 30, 2010 and 2009*

 

Grossprofit was $12.1 million, or 20% of net sales, in the three months endedSeptember 30, 2010 compared to $24.2 million, or 34% of net sales, inthe corresponding period of 2009. The gross margin from Broadband segment wasreduced $9.6 million primarily as a result of an $8.5 million inventory reservefor MSAN and MSTP for two international customer contracts due to reduction inproduct demands.  The gross margin fromHandset sales was reduced $3.7 million as a result of the wind-down of ourhandset business. The gross margin from Multimedia Communications increased$1.2 million, benefiting $5.8 million for the three months ended September 30,2010 from the impact of the release of accrued third party commissions as a result of expiration of statute oflimitations, compared with $0.7 million during the three  months ended September 30, 2009,  and benefiting from the acceleration of PASdeferred product revenue amortization, partially offset by reserve forunrecoverable output VAT and decreased gross margins in all other major productlines of the segment .

 

*Nine months ended September 30, 2010 and 2009*

 

Grossprofit was $62.2 million, or 29% of net sales, in the nine months endedSeptember 30, 2010 compared to $30.0 million, or 11% of net sales, inthe corresponding period of 2009. There was $27.9 million gross profit increasein Handset segment for the nine months ended September 30, 2010 comparedto the same period in 2009 primarily resulting from the wind-down of ourHandsets segment during 2009. Gross profit in Handset segment of $3.3 millionfor the nine months ended September 30, 2010 related primarily toinventory clearing sales compared with negative gross profit of $24.6 millionfor the nine months ended September 30, 2009 which was impacted byadditional inventory reserves and claim settlements with PCD LLC, partiallyoffset by an $8.5 million decrease to cost of sales in the Handsets segmentresulting from the amortization of the Marvell supply agreement during thefirst quarter of 2009. Compared to the nine months ended September 30,2009, Broadband Infrastructure segment contributed $3.3 million increase ingross profit in the same period of 2010, primarily due to increased sales ofhigher margin TN products, including approximately $2.4 million from the releaseof previously deferred revenue carve-out for potential penalty and cancellationpenalties  in 2010 compared to 2009, partially offset by an$8.5 million inventory reserve in the third quarter of 2010 for MSAN and MSTPproducts for two international customer contracts due to reduction in demand. The grossmargin from Multimedia Communications increased $1.0 million, benefiting $6.0million for the nine months ended September 30, 2010 from the impact ofthe release of accrued third party commissions as a result of expiration of statute of limitations, compared with$0.8 million for the and nine months ended September 30, 2009,  and benefiting from the acceleration of PAS deferred product revenue amortization of MultimediaCommunications segment, partially offset by the decrease in sales of otherMultimedia Communications.

 

Foradditional discussion, see the “Segment Reporting” section of this Item 2.

 

**OPERATING EXPENSES**

 

Thefollowing table summarizes our operating expenses:

 
| ** **                          | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | ** **                                               | ** ** | **% of**                                           | ** ** | ** ** | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                          | ** ** | ** **                                               | ** ** | **net**                                                 | ** ** | ** ** | ** ** | **net** | ** ** | ** ** | ** ** | **net** | ** ** | ** ** | ** ** | **net** | ** ** |
| ** **                          | ** ** | **2010**                                                 | ** ** | **sales**                                               | ** ** | **2009** | ** ** | **sales** | ** ** | **2010** | ** ** | **sales** | ** ** | **2009** | ** ** | **sales** | ** ** |
| ** **                          | ** ** | **(in thousands, except percentages)**    | ** ** |
| Selling, general and administrative |       | $                                                        | 24,530     |                                                    | 40         | % | $ | 33,139 |   | 47 | % | $ | 75,882 |   | 35 | % | $ | 114,290 |   | 42 | % |
| Research and development            |       | 9,922                                                    |       | 16                                                      | %          | 14,246 |   | 20 | % | 29,023 |   | 13 | % | 51,983 |   | 19 | % |
| Restructuring                       |       | 2,336                                                    |       | 4                                                       | %          | 8,909 |   | 13 | % | 9,627 |   | 4 | % | 41,485 |   | 16 | % |
| Loss (gain) on divestitures         |       | (1,436                                                   | )          | (2                                                      | )%         | 1,689 |   | 2 | % | (5,244 | ) | (2 | )% | 332 |   | 0 | % |
| Total net operating expenses        |       | $                                                        | 35,352     |                                                    | 58         | % | $ | 57,983 |   | 82 | % | $ | 109,288 |   | 50 | % | $ | 208,090 |   | 77 | % |

 

Selling,general and administrative expenses (“SG&A”) include compensation andbenefits, professional fees, internal sales commissions, provision for doubtfulaccounts receivable and travel and entertainment costs. Research anddevelopment (“R&D”) expenses consist primarily of compensation and benefitsof employees engaged in research, design and development activities, costs ofparts for prototypes, equipment depreciation and third party developmentexpenses. We believe that continued and prudent investment in research anddevelopment is critical to our long-term success, and we will aggressivelyevaluate appropriate investment levels. A portion of our costs are fixed and are difficult to quickly reduce inperiods of lower sales.

 

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*SELLING, GENERAL AND ADMINISTRATIVE*

 

*Threemonths ended September 30, 2010 and 2009*

 

SG&Aexpenses were $24.5 million forthe three months ended September 30, 2010, a decrease of $8.6 million as compared to $33.1 million forthe same period in 2009. The decrease in SG&A expense was primarily due toa $5.9 million decrease in personnel related expenses as a result of ourrestructuring actions and recent cost reduction measures, a $1.1 millionreduction in legal and accounting fees as a result of reduced activity ininvestigations and litigation, a $0.6 million reduction in advertising andmarketing, sales promotions, as well as shows and exhibits expenses due to reducedsales activities, a $1.3 million decrease in facility related expenses, a $0.6million reduction in other taxes, fees, licenses, a $2.5 million reduction inother operating cost, and a $0.2 million reduction in insurance as a result ofthe reduced cost structure. These cost savings were partially offset by a $0.3million increase in travel related expense as well as a $1.9 million provisionfor doubtful accounts during the three months ended September 30, 2010related to aging receivables compared to $1.6 million recovery of doubtfulaccounts in the same period of 2009.

 

*Ninemonths ended September 30, 2010 and 2009*

 

SG&Aexpenses were $75.9 million for thenine months ended June 30, 2010, a decrease of $38.4 million as compared to $114.3million for the same period in 2009. The decrease in SG&A expensewas primarily due to a $26.9 million decrease in personnel related expenses asa result of our restructuring actions and recent cost reduction measures, a$6.6 million reduction in legal and accounting fees as a result of reducedactivity in investigations and litigation, a $2.7 million reduction inadvertising and marketing, sales promotions, as well as shows and exhibitsexpenses due to reduced sales activities, a $0.8 million savings from reductionin the use of outside services, a $0.9 million decrease in travel relatedexpenses due to reduced travel activity and cost containment efforts ,  a $4.0 million decrease in facility relatedexpenses, a $1.4 million reduction in other taxes, fees, licenses, a $2.7million reduction in other operating cost and a $0.8 million reduction ininsurance as a result of the reduced cost structure. These cost savings werepartially offset by a $6.1 million provision for doubtful accounts related toaging receivables compared to $3.7 million recovery of doubtful accounts in thesame period of 2009 resulting primarily from collection of long-agedreceivables.

 

*RESEARCH AND DEVELOPMENT*

 

*Three months ended September 30, 2010 and 2009*

 

R&D expenses decreased by $4.3million during the three months ended September 30, 2010 comparedto the same period in 2009.  The decreasewas mainly due to a $2.7 milliondecrease in personnel related expense as a result of our restructuring actions,$0.3 million savings fromreduction in use of outside services, and a total of $1.2 million decrease in depreciation, software license, parts andfacilities related expenses as we continued to streamline our operations andwind down our handset business unit.

 

*Nine months ended September 30, 2010 and 2009*

 

R&D expenses decreased by $23.0 millionduring the nine months ended September 30, 2010 compared to the sameperiod in 2009.  The decrease was mainlydue to a $16.1 million decrease inpersonnel related expense as a result of our restructuring actions, $2.0 million savings from reduction in use of outside services, and a totalof $4.5 million decrease indepreciation, software license, parts and facilities related expenses as wecontinued to streamline our operations and wind down our handset business unit.

 

*RESTRUCTURING*

 

*Three and nine months ended September 30, 2010*

 

During the three months and nine months endedSeptember 30, 2010, we recorded approximately $2.3 million and $9.6million in restructuring charges.

 

OnJune 9, 2009, our Board of Directors approved a restructuring plan (the “2009Restructuring Plan”) designed to reduce our operating costs. The 2009Restructuring Plan includes a worldwide reduction in force of approximately 50%of our headcount, or approximately 2,300 employees located primarily in Chinaand the United States and, to a lesser degree, other international locations.During the three months ended September 30, 2010, we recordedrestructuring costs of approximately $2.2 million related to the 2009Restructuring Plan, net of approximately $0.2 million of reversal of chargesrecorded in fiscal year 2009. During the nine months ended September 30,2010, we recorded restructuring costs of approximately $9.1 million related tothe 2009 Restructuring Plan, net of approximately $1.9 million of reversal ofcharges recorded in prior periods. The restructuring costs for the nine monthsended September 30, 2010 consist primarily of severance and benefitsrelated to additional employees included in the Restructuring Plan,  adjusted for change in estimate,  and approximately $1.1 million of lease costsprimarily related to a lease expiring in 2013. Total restructuring costsrecorded through September 30, 2010 related to the 2009 Restructuring**Planapproximated $49.1 million.

 

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Duringfiscal 2008, we implemented a restructuring plan (the “2008 Restructuring Plan”)primarily related to a global reduction in force across all functions andemployee terminations at certain non-core operations which we were in theprocess of winding down. The number of employees affected totaled approximately750, including 350 in China, 200 in Korea and 200 in other locations includingthe United States. During the three and nine months ended September 30,2010, we recorded additional restructuring costs related to the 2008Restructuring Plan of approximately $0.1 million and $0.5 million,respectively, for severance and benefit costs being recognized over theremaining service period for employees included in the 2008 Restructuring Plan.Total restructuring costs recorded through September 30, 2010 related tothe 2008 Restructuring**Plan approximated $19.9 million.

 

*Three and nine months ended September 30, 2009*

 

Duringthe three and nine months ended September 30, 2009, the Company recordedrestructuring costs of approximately $9.2million and $35.1 million,respectively, related to the 2009 Restructuring Plan.  Restructuring costs for the nine months endedSeptember 30, 2009 included $33.6 millionfor severance and benefits related to approximately 2,070 employees and $1.5 million related primarily to theestimated loss on a lease obligation which expires in 2013.

 

Themajority of the remaining cash expenditures related to the 2009 and 2008Restructuring Plans are expected to be paid in 2010. The remaining liabilitiesrelated to lease obligations are expected to be settled over the remaininglease term. We expect to incur additional restructuring charges in 2010 as wecontinue to execute the 2009 and 2008 Restructuring Plans.

 

*GAIN ONDIVESTITURES*

 

*Threeand nine months ended September 30, 2010*

 

Gainon divestitures for the three months ended September 30, 2010 of $1.4million included a $1.6 million gain on sales of China PDSN Assets in the thirdquarter of 2010, a $0.7 million additional gain on divestiture resulting from$0.7 million contingent consideration received related to our second quarter2010 divestiture of IP Messaging and US PDSN Assets, offset partially by a $0.9million loss on transfer of EMEA operations in the third quarter of 2010. SeeNote 3 to our Condensed Consolidated Financial Statements included underPart 1, Item 1 of this Quarterly Report on Form 10-Q foradditional information regarding gain on divestitures.

 

Gainon divestitures for the nine months ended September 30, 2010 of $5.2million was comprised of the $1.6 million gain on sale of China PDSN Assets,the $0.9 million loss on transfer of EMEA operations, $2.8 million gain on saleof IP Messaging and US PDSN Assets and $1.8 million gain on sale of the RASproduct line in the first quarter of 2010.

 

*Threeand nine months ended September 30, 2009*

 

Losson divestiture for the three months ended September 30, 2009 was comprisedof a $1.7 million loss from the divestiture of our Korea operations. The losson divestiture of $0.3 million for the nine months ended September 30,2009 was comprised of the $1.7 million loss from the divestiture of our Korea operations,offset partially by a $1.4 million gain on sale of PCD assets resulting from anadjustment to reflect actual transaction-related costs.

 

*STOCK-BASED COMPENSATION EXPENSE*

 

AtSeptember 30, 2010, there was approximately $4.0 million of totalunrecognized compensation cost not including forfeitures, as measured, relatedto non-vested stock options and restricted stock and restricted stock units,which is expected to be recognized over a weighted-average period of 2.3 years.The following table summarizes the stock-based compensation expense in ourconsolidated statement of operations:

 
| ** **                          | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                          | ** ** | **(in thousands)**                                  | ** ** |
| Cost of net sales                   |       | $                                                        | 42         |                                                    | $          | 101 |   | $ | 135 |   | $ | 592 |   |
| Selling, general and administrative |       | 901                                                      |       | 1,516                                                   |       | 3,381 |   | 5,572 |   |
| Research and development            |       | 202                                                      |       | 237                                                     |       | 563 |   | 1,321 |   |
| Restructuring                       |       | 439                                                      |       | 1,153                                                   |       | 2,052 |   | 1,949 |   |
| Total                               |       | $                                                        | 1,584      |                                                    | $          | 3,007 |   | $ | 6,131 |   | $ | 9,434 |   |

 

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**OTHERINCOME (EXPENSE)**

 

*INTEREST INCOME*

 

*Three and nine months ended September 30, 2010 and 2009*

 

Interestincome was $0.6 million and $0.5 million for the three months endedSeptember 30, 2010 and 2009, respectively. Interest income was$1.4 million and $1.8 million for the nine months ended September 30,2010 and 2009, respectively. Interest income decreased for the nine monthsended September 30, 2010 compared to the same period in 2009, primarilydue to a decline in the average interest rate.

 

*INTEREST EXPENSE*

 

*Three and nine months ended September 30, 2010 and 2009*

 

Interestexpense was $0.1 million and $0.1 million for the three months endedSeptember 30, 2010 and 2009, respectively. Interest expense was$0.2 million and $0.5 million for the nine months ended September 30,2010 and 2009, respectively. The decrease in interest expense for the ninemonths ended September 30, 2010 compared to the same period in 2009 was primarilyattributable to the decreased use of credit facilities in 2010.

 

*OTHER INCOME (EXPENSE), NET*

 

*Three months ended September 30, 2010 and 2009*

 

Otherincome, net was $7.0 million for the three months ended September 30, 2010as compared to other expense, net of $1.6 million for the three months endedSeptember 30, 2009. Other income, net of $7.0 million for the three monthsended September 30, 2010 consisted primarily of $6.9 million of foreigncurrency gains primarily resulting from intercompany receivables in IndianRupee and Chinese Renminbi.  Otherexpense, net of $1.6 million for the three months ended September 30, 2009consisted primarily of a $1.7 million other-than-temporary impairment of anequity investment.

 

*Nine**months ended September 30, 2010 and 2009*

 

Otherincome, net for the nine months ended September 30, 2010 was $7.1 millionas compared to expense of $3.3 million for the nine months endedSeptember 30, 2009. Other income, net for the nine months endedSeptember 30, 2010 consisted primarily of $6.1 million of foreign currencygains primarily resulting from intercompany receivables in Indian Rupee and ChineseRenminbi, $0.5 million settlement proceeds with MRV Communications (“MRV”)related to our investment in MRV which was sold in 2009, and $0.5 million ofother individually insignificant items. Other expense, net for the nine monthsended September 30, 2009 consisted primarily of a $5.5 millionother-than-temporary impairment of two equity investments, offset partially byforeign currency gains of $1.7 million and $0.5 million of otherindividually insignificant items.

 

*INCOME TAX EXPENSE*

 

Incometax expense is based upon a blended effective tax rate based upon ourexpectation of the amount of income to be earned in each tax jurisdiction andis accounted under the liability method. Deferred income taxes are recognizedfor the differences between the tax bases of assets and liabilities and theirfinancial statement amounts based on enacted tax rates. Valuation allowancesare established when necessary to reduce deferred tax assets to the amountexpected to be realized. We expect to maintain a full valuation allowance onour remaining net deferred tax assets until an appropriate level ofprofitability that generates taxable income is sustained or until we are ableto develop tax strategies that would enable us to conclude that it is morelikely than not that a portion of our deferred tax assets will be realizable.Any reversal of valuation allowances will favorably impact our results ofoperations in the period of the reversal.

 

FASB ASC 740-10 establishes criteria for recognizingor continuing to recognize only more-likely-than-not tax positions, which mayresult in income tax expense volatility in future periods. While we believe thatwe have adequately provided for all tax positions, amounts asserted by taxingauthorities could be greater than our accrued position. Accordingly, additionalprovisions on income tax related matters could be recorded in the future asrevised estimates are made or the underlying matters are settled or otherwiseresolved.

 

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* *

*Three months ended September 30, 2010 and 2009*

 

Incometax expense was $1.4 million for the three months ended September 30, 2010compared to income tax benefit of $0.3 million for the three months endedSeptember 30, 2009. Income tax benefit of $0.3 million for the threemonths ended September 30, 2009 was mainly due to one-time tax benefitrelated to the change in India withholding taxes.

 

*Ninemonths ended September 30, 2010 and 2009*

 

Incometax expense was $3.2 million for the nine months ended September 30,2010 compared to $6.2 million for the nine months ended September 30,2009.  The decrease in income tax expensein the nine months ended September 30, 2010 compared with nine month endedSeptember 30, 2009 was primarily due to the decreased ordinary income injurisdictions where the Company has been profitable and a one-time tax expenseof $1.4 million in the three months ended June 30, 2009 related toestablishing of valuation allowance on net deferred tax assets in Korea.

 

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**SEGMENT REPORTING**

 

Summarizedbelow are our segment net sales and gross profit for the three and nine monthsended September 30, 2010 and 2009, respectively.

 

***Multimedia Communications***

 

**Multimedia Communications**

 
| ** **                                | ** ** | **Three months ended  September 30,**  | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2010**                                              | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                | ** ** | **(in thousands, except percentages)** | ** ** |
| Net sales                                 |       | $                                                     | 39,500     |                                                | $          | 30,044 |   | $ | 128,811 |   | $ | 120,520 |   |
| Gross profit                              |       | $                                                     | 14,055     |                                                | $          | 12,884 |   | $ | 42,626 |   | $ | 41,587 |   |
| Gross profit as a percentage of net sales |       | 36                                                    | %          | 43                                                  | %          | 33 | % | 35 | % |

 

Duringthe three months ended September 30, 2010, Multimedia Communicationssegment’s sales were $39.5 million as compared to $30.0 million for the sameperiod in 2009 as the accelerated PAS deferred product revenue amortization andthe increase in sales of Set Top Box (“STB”) product offset the decrease inrevenue of all other major product lines. Amortization of PAS deferred productrevenue accounted for $23.2 million or 59% of Multimedia Communication salesfor the three months ended September 30, 2010, compared to $10.5 millionor 35% for the same period in 2009. Revenue from STB product accounted for 13%and 8% of Multimedia Communications segments in the third quarter of 2010 and2009, respectively.

 

Duringthe nine months ended September 30, 2010, sales of MultimediaCommunications segment were $128.8 million as compared to $120.5 million forthe same period in 2009 as accelerated PAS deferred product revenueamortization and the increase in sales of STB product offset the decrease inrevenue of all other major product. Amortization of PAS deferred productrevenue accounted for $69.5 million or 54% of Multimedia Communications salesfor the nine months ended September 30, 2010, compared to $31.5 million or26% for the same period in 2009.

 

Thegross profit as a percentage of net sales decreased to 36% for the three monthsended September 30, 2010 from 43% for the corresponding period in 2009.The decrease in gross profit percentage was mainly due to increase in lossorder provision and inventory provision for IPTV products, and more revenuefrom STB product with low gross margin, partially offset by an increase inthird party commission reversal for PAS product and acceleration of PASdeferred product revenue amortization in the third quarter of 2010.  During the three and nine months ended September 30,2010, gross profit benefited $5.8 and $6.0 million, respectively, from theimpact of the release of accrued third party commissions as a result of expiration of statute oflimitations, compared with $0.7 million and $0.8 million, respectively,during the three and nine months ended September 30, 2009. The gross profitas a percentage of net sales decreased to 33% for the nine months ended September 30,2010 from 35% for the corresponding period in 2009. The decrease was primarilydue to an approximately $1.0 million benefit to gross profit in the nine monthsended September 30, 2010 from sales of product inventory which was previously fullyreserved, compared to $5.1 million for the same period of 2009.

 

In2010 and beyond, we do not expect significant new contracts for our PAShandsets and infrastructure equipment.We plan to aggressively pursue opportunitiesfor our IPTV product portfolios in multiple markets. We believe that the IPTVmarket presents a meaningful growth opportunity. We currently offer and haveinitial market acceptance of our IPTV products in China, India, Taiwan andother geographic regions.

 

***BroadbandInfrastructure***

 

**Broadband Infrastructure**

 
| ** **                                | ** ** | **Three months ended  September 30,**  | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2010**                                              | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                | ** ** | **(in thousands, except percentages)** | ** ** |
| Net sales                                 |       | $                                                     | 21,068     |                                                | $          | 24,847 |   | $ | 80,303 |   | $ | 64,629 |   |
| Gross profit                              |       | $                                                     | (1,581     | )                                                   | $          | 7,983 |   | $ | 16,264 |   | $ | 13,013 |   |
| Gross profit as a percentage of net sales |       | (8                                                    | )%         | 32                                                  | %          | 20 | % | 20 | % |

 

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BroadbandInfrastructure sales decreased by 15% and increased by 24%, respectively,during the three and nine months ended September 30, 2010 as compared tothe same periods in 2009.  The decreasein sales for the three months ended September 30, 2010 was due to thedecrease in sales of several product lines except for TN, CPE and MSTPproducts. The increase in sales for the nine months ended September 30,2010 was mainly due to the increase in sales of MSAN products, including $11.9million revenue from an international customer in the first quarter of 2010.Also contributing to the increase in sales for the nine months endedSeptember 30, 2010 was the increase in sales of most major product lines,offset partially by a decrease in sales of MSTP and service.  TN product revenue comprised approximately 29% and0% of Broadband Infrastructure sales for the three months endedSeptember 30, 2010 and 2009, respectively.TN product revenue comprised approximately 14% and0% of Broadband Infrastructure sales for the nine months endedSeptember 30, 2010 and 2009, respectively. Softbank in Japan, one ofour largest infrastructure customers, represented approximately 54% and 19% oftotal Broadband sales during the three months ended September 30, 2010 and2009, respectively, and 41% and 25% during the nine months endedSeptember 30, 2010 and 2009, respectively.

 

Duringthe fourth quarter of 2009, we began recognizing revenue ratably on asignificant customer contract over the seven year post contract support periodand in the third quarter of 2010 we began recognizing revenue ratably on thesecond phase of this contract, also over the seven year post contract supportperiod. For the three and nine months ended September 30, 2010, werecognized revenue of $5.2 million and $11.9 million, respectively, andimmaterial gross profit on both phases of the contracts.

 

Grossprofit percentage decreased to negative 8% for the three months endedSeptember 30, 2010 from 32% for the corresponding period of 2009. Thedecrease in gross profit percentage was primarily due to an $8.5 million inventoryreserve for MSAN and MSTP for two contracts due to reduction in product demand,and decreased sales of service which was partially offset by TN product saleswith high margin. Gross profit percentage remained stable at 20% for the nine months endedSeptember 30, 2010 and the corresponding period of 2009. The gross profitpercentage was impacted by the increase in TN product sales with high margin product sales, includingapproximately $2.4 million from the release of previously deferred revenuecarve-out for potential penalty and cancellation penalties, partially offset by the impact of higher inventoryreserve for MSAN and MSTP products.

 

Wemay incur additional warranty expense and inventory reserves as we introducenew products and may be required to accrue additional contract losses forcertain fixed price contracts as these contracts progress. These factors willresult in negative impacts on our future gross margins, results of operationsand financial position.

 

***Handsets***

 
| ** **                                | ** ** | **Three months ended  September 30,**  | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2010**                                              | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                | ** ** | **(in thousands, except percentages)** | ** ** |
| Net sales                                 |       | $                                                     | 826        |                                                | $          | 15,613 |   | $ | 6,292 |   | $ | 84,858 |   |
| Gross profit                              |       | $                                                     | (381       | )                                                   | $          | 3,322 |   | $ | 3,284 |   | $ | (24,597 | ) |
| Gross profit as a percentage of net sales |       | (46                                                   | )%         | 21                                                  | %          | 52 | % | (29 | )% |

 

Netsales decreased by 95% and 93% for the three and nine months ended September 30, 2010,respectively, compared to the same period in 2009.  The decrease wasprimarily due to the substantial wind-down of our worldwide handset business.Except for sales related to inventory clearing, we do not expect anysignificant handset revenue in 2010.

 

Grossprofit as a percentage of net sales decreased from 21% for the three monthsended September 30, 2009 to negative 46% for the corresponding period in2010. The decrease was mainly due to additional royalty accrual of $0.6 millionin the three months ended September 30, 2010.

 

Grossprofit as a percentage of net sales increased from negative 29% for the ninemonths ended September 30, 2009 to 52% for the corresponding period in2010. The increase was mainly due to inventory clearing sales of PAS and CDMAhandsets which were previously fully reserved. We incurred additional warrantyreserve recorded during the first quarter of 2009 due to additional repairs forone of our handset products, and additional inventory reserve for our PAShandsets as we anticipated decrease in demand after China launched its 3Gnetworks. In addition, gross profit was also reduced by approximately $ 26.2million as a result of transactions with PCD LLC consisting of a claimsettlement of $11.1 million for product-related liability disputes andproduct returns and $ 15.1 million of costs for inventory write-downs to netrealizable value, write-downs of excess inventory and warranty reserves.

 

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**RELATEDPARTY TRANSACTIONS**

 

Softbankand affiliates

 

Werecognize revenue with respect to sales of telecommunications equipment toaffiliates of Softbank, a significant stockholder of the Company. Softbankoffers ADSL coverage throughout Japan, which is marketed under the name “YAHOO!BB.” We support Softbank’s fiber-to-the-home service through sales of ourcarrier class GEPON product as well as our NetRingÔ product. In addition, wesupport Softbank’s new internet protocol television (“IPTV”), through sales ofour RollingStreamÔ product.During the three and nine months ended September 30, 2010 and 2009, werecognized revenue and related cost of net sales for sales oftelecommunications equipment and services to affiliates of Softbank as follows.

 
| ** **        | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **        | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **        | ** ** | **(in thousands)**                                  | ** ** |
|              |       |                                                     |       |                                                    |       |   |   |   |   |
| Net sales         |       | $                                                        | 11,356     |                                                    | $          | 4,832 |   | $ | 32,868 |   | $ | 16,030 |   |
| Cost of net sales |       | 3,771                                                    |       | 2,552                                                   |       | 12,739 |   | 9,310 |   |
| Gross profit      |       | $                                                        | 7,585      |                                                    | $          | 2,280 |   | $ | 20,129 |   | $ | 6,720 |   |

 

Grossprofit as a percentage of net sales fluctuations are expected and generallyresult from changes in product mix. In the nine months ended September 30,2010, gross profit as a percentage of net sales also benefited approximately$2.4 million from the release of previously deferred revenue carve-out forpotential penalty and cancellation penalties as a result of completing theseobligations. Included in accounts receivable at September 30, 2010 andDecember 31, 2009 were $13.0 million and $5.5 million, respectively,related to these transactions.

 

Salesto Softbank include a three year service period and a penalty clause if productfailure rates exceed a certain level over a seven year period. As ofSeptember 30, 2010 and December 31, 2009, our customer advancebalance related to Softbank agreements was $0.2 million and $0.2 million,respectively. The current deferred revenue balance related to Softbank was $1.2million and $1.4 million as of September 30, 2010 and December 31,2009, respectively. As of September 30, 2010, our noncurrent deferredrevenue balance related to Softbank was $7.3 million compared to $8.8 millionas of December 31, 2009.

 

Asdiscussed in Note 6 to our condensed consolidated financial statements includedunder Part 1, Item 1 of this Quarterly Report on Form 10-Q, wehave a $1.1 million investment in SBI. Affiliates of Softbank have a controllinginterest in SBI.

 

Asof September 30, 2010, Softbank beneficially owned approximately 10% ofour outstanding stock.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

**Liquidity and Capital Resources**

 

The following sections discuss the effects ofchanges in our balance sheet and cash flows, contractual obligations and othercommitments on our liquidity and capital resources.

 

***Balance Sheet and Cash Flows***

 

Cash and Cash Equivalents and Short-termInvestments

 
| ** **                          | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-----------------------|------------|------------|------------|
| ** **                          | ** ** | **2010**                | ** ** | **2009**              | ** ** | **Change** | ** ** |
| ** **                          | ** ** | **(in thousands)** | ** ** |
|                                |       |                    |       |                  |       |       |       |
| Cash and cash equivalents           |       | $                       | 337,026    |                  | $          | 265,843    |       | $ | 71,183 |   |
| Short-term investments - Bank notes |       | 972                     |       | 1,038                 |       | (66        | )          |
| Total                               |       | $                       | 337,998    |                  | $          | 266,881    |       | $ | 71,117 |   |

 
| ** **                                                    | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2010**                                                | ** ** | **2009** | ** ** | **Change** | ** ** |
| ** **                                                    | ** ** | **(in thousands)**                                 | ** ** |
| Cash used in operating activities                             |       | $                                                       | (97,405    | ) | $ | (89,202 | ) | $ | (8,203 | ) |
| Cash provided by investing activities                         |       | 127,652                                                 |       | 14,900 |   | 112,752 |   |
| Cash provided by (used in) financing activities               |       | 34,536                                                  |       | (388 | ) | 34,924 |   |
| Effect of exchange rate changes on cash and cash  equivalents |       | 6,400                                                   |       | 2,199 |   | 4,201 |   |
| Net increase (decrease) in cash and cash  equivalents         |       | $                                                       | 71,183     |   | $ | (72,491 | ) | $ | 143,674 |   |

 

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Cash and cash equivalents, consistingprimarily of bank deposits and money market funds, are recorded at cost whichapproximates fair value because of the short-term nature of theseinstruments. At September 30,2010, cash and cash equivalents approximating $202.9 million was held by oursubsidiaries in China.

 

Cash used in operating activities during the ninemonths ended September 30, 2010 of $97.4 million resulted primarily fromthe net loss of $42.1 million, adjusted for $5.2 million gains from investingactivities, and by changes in net operating assets and liabilities using netcash of $65.3 million, partially offset by non-cash charges including $4.2million of depreciation and amortization, $6.1 million stock-based compensationand $6.0 million provision for doubtful accounts. Changes in net operatingassets and liabilities using net cash during the nine months endedSeptember 30, 2010 included $32.4 million for settlement of accountspayable and $54.4 million for settlement of other liabilities as the Companycontinues to streamline operations. Cash used in operatingactivities during the nine months ended September 30, 2009 of $89.2million resulted primarily from the net loss of $186.3 million offset bynon-cash charges including $10.2 million of depreciation and amortization, $9.4million stock-based compensation, $5.5 million other-than-temporary impairmentof two equity investments and also offset by changes in operating assets andliabilities providing net cash of $73.6 million.  The decrease in sales activity in the firstnine months of 2009 was the primary driver of the changes in operating assetsand liabilities.

 

Cash provided by investing activities during thenine months ended September 30, 2010 of $127.7 million included netproceeds from divestiture of $2.8 million, proceeds from sale of building of$124.0 million, and changes in restricted cash of $7.4 million, offsetpartially by cash outflows including $4.2 million for net purchases ofshort-term investments, $2.6 million for purchases of property, plant andequipment and $0.5 million for purchase of an investment interest. Cashoutflows of approximately $4.2 million for net purchases of short-terminvestments related primarily to a non-qualified deferred compensation planestablished in fiscal 2010 which allows a six-month deferral of compensationfor certain employees. Cashprovided by investing activities during the nine months ended September 30,2009 was $14.9 million. Cashprovided from investing activities in the nine months ended September 30,2009 included $10.0 million of cash proceeds released from escrow inJuly 2009 related to sale of PCD, $1.6 million of cash proceeds from thesale of our investment in PCD LLC and $1.5 million cash proceeds from thedivestiture of our Korea operations.

 

Cashprovided by financing activities during the nine months endedSeptember 30, 2010 consist primarily of net cash proceeds of $34.6 millionfrom issuance of 18.1 million shares of common stock and an option to purchasean additional 4.0 million of common stock through November 8, 2010. SeeNote 11 to our Condensed Consolidated Financial Statements included underPart 1, Item 1 of this Quarterly Report on Form 10-Q foradditional discussion .Cash used in financing was immaterial during the ninemonths ended September 30, 2009.

 

Accounts Receivable, Net

 

Accountsreceivable decreased $0.7 million from $42.3 million at December 31, 2009to $41.6 million at September 30, 2010. At September 30, 2010, ourallowance for doubtful accounts was $32.4 million on gross receivables of $74.0million. We recorded provision for doubtful accounts of $1.9 million and $6.1million for the three and nine months ended September 30, 2010,respectively, related to aging receivables resulting from a slowdown incustomer payments. We recorded net recoveries of doubtful accounts ofapproximately $1.6 million and $3.6 million for the three and nine months endedSeptember 30, 2009, respectively, primarily due to significant collectionof long-aged receivables during the second quarter of 2009, partially offset byprovision for doubtful accounts. We assess collectability of receivables basedon a number of factors including analysis of creditworthiness, our customer’shistorical payment history and current economic conditions, our ability tocollect payment and on the length of time an individual receivable balance isoutstanding. We have certain accounts receivable in China that have beenoutstanding for a significant period of time. We provide allowances for thesereceivables based on the criteria discussed above. While we believe we havesufficient experience and knowledge of the China market and customer paymentpatterns to reasonably estimate such allowances, actual payment patterns andcustomer behavior could differ from our expectations.

 

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Inventoriesand Deferred Costs

 

Thefollowing table summarizes our inventories and deferred costs:

 
| ** **                | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** | **Increase**   | ** ** |
|---------------------------|------------|-------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                | ** ** | **2010**                | ** ** | **2009**              | ** ** | **(Decrease)** | ** ** |
| ** **                | ** ** | **(in thousands)** | ** ** |
| Inventories:              |       |                    |       |                  |       |           |       |
| Raw materials             |       | $                       | 4,733      |                  | $          | 18,863         |       | $ | (14,130 | ) |
| Work in-process           |       | 14,967                  |       | 12,881                |       | 2,086          |       |
| Finished goods            |       | 32,157                  |       | 40,556                |       | (8,399         | )          |
| Total inventories         |       | $                       | 51,857     |                  | $          | 72,300         |       | $ | (20,443 | ) |
|                      |       |                    |       |                  |       |           |       |
| Short-term deferred costs |       | $                       | 122,540    |                  | $          | 130,453        |       | $ | (7,913 | ) |
| Long-term deferred costs  |       | $                       | 152,562    |                  | $          | 184,978        |       | $ | (32,416 | ) |

 

Inventoriesconsist of product held at our manufacturing facility and warehouses, as wellas finished goods at customer sites for which the customer has takenpossession, but based on specific contractual terms, title has not yet passedto the customer. Finished goods at customer sites were approximately $21.4million and $33.8 million at September 30, 2010 and December 31,2009, respectively.

 

Inventoriesof approximately $0.8 million held by our manufacturing outsource partner are recordedin Prepaids and other current assets in the condensed consolidated balancesheet at September 30, 2010. No inventories were held by our manufacturingoutsource partner at December 31, 2009. The Company recorded an $8.5 millioninventory reserve in the third quarter of 2010 for MSAN and MSTP for twointernational customer contracts due to the reduction in product demands.

 

***Liquidity***

 

Wehave incurred net losses of $225.7 million, $150.3 million and $195.6 millionduring the years ended December 31, 2009, 2008 and 2007, respectively.During the nine months ended September 30, 2010, we incurred a net loss of$42.1 million. We have recorded operating losses in 22 of the 23 consecutivequarters in the period ended September 30, 2010. At September 30,2010, we have an accumulated deficit of $1, 109.3million. we incurred net cashoutflows from operations of $67.4 million, $55.2 million and$225.1 million in 2009, 2008 and 2007 respectively. Cash used in operationswas $97.4 million during the nine months ended September 30, 2010. Whileoperating results are expected to improve in 2010 compared with prior years, weexpect to continue to incur losses for the remainder of 2010.

 

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AtSeptember 30, 2010, we had cash and cash equivalents of$337.0 million, of which $202.9 million was held by our subsidiaries inChina. The amount of cash available for transfer from the China subsidiarieswill be limited both by the liquidity needs of the subsidiaries in China andthe restriction on currency exchange by Chinese-government mandatedrequirements including currency exchange controls on certain transfers of fundsoutside of China.

 

AtSeptember 30, 2010, we had approximately $28.7 million of available creditfacilities. In the second quarter of 2010, we enteredinto two credit facilities totaling $29.4 million. Both credit facilitiescan be used for the issuance of certain letters of credit and guaranteesand both facilities expire in the second quarter of 2011.

 

Globaleconomies have experienced a significant downturn driven by a financial andcredit crisis that will continue to challenge such economies for some period oftime. Under the current macroeconomic environment there are significant risksand uncertainties inherent in management’s ability to forecast future results.The operating environment confronting us, both internally and externally,raises significant uncertainties.

 

Inthe past two years, we took a number of actions to improve our liquidity. InMarch 2008, we paid $289.5 million to retire our convertiblesubordinated notes and related accrued interest. On July 1, 2008, wecompleted the sale of PCD. In addition, we divested our Mobile SolutionsBusiness Unit in July 2008. In the fourth quarter of 2008, managementinitiated actions to disband our Custom Solutions Business Unit, to wind downour Korea based handset operations, and announced initiatives including effortsto eliminate functional duplications by consolidation of a number of functionsinto our China operations. In June 2009, management expanded theinitiatives to include a worldwide reduction in workforce, outsourcing ofmanufacturing operations and optimizing research and development spending witha focus on selected products. Our year-to-year quarterly selling, general andadministrative and research and development operating expenses decreased significantlyin 2009 compared with 2008 and management believes the continuing efforts tostream-line operations will enable our fixed cost base to be better alignedwith operations, market demand and projected sales levels. If projected salesdo not materialize, we will need to take further actions to reduce costs andexpenses or explore other cost reduction options.

 

InDecember 2009, we entered into a Sales Leaseback Agreement for the sale ofour manufacturing, research and development, and administrative officesfacility in Hangzhou, China to another third party for approximately$138.8 million with leaseback of a portion of the facility. On May 31,2010, the buyer and we agreed that all conditions precedent to the closing hadbeen met and the leaseback commenced on June 1, 2010. As of May 31,2010, we had received all of the sales proceeds and met all criteria forconsummation of sale of the Hangzhou facility.

 

OnFebruary 1, 2010, we entered into agreements for a strategic relationshipwith Beijing E-town International Investment and Development Co., Ltd(“BEIID”) which included a proposed investment of $48.5 million in ourcommon stock by BEIID, and two unrelated investment funds, Elite Noble Limitedand Shah Capital Opportunity Fund LP. These investments closed in September 2010.Under the revised terms, we received a cash of $34.6 million, net of issuancecosts, and issued approximately 18.1 million shares of common stock and anoption to purchase up to an additional 4.0 million shares of common stock forapproximately $8.1 million through November 8, 2010.

 

Managementbelieves that both our China and non-China operations have sufficient liquidityto finance working capital and capital expenditure needs during the next12 months. There can be no assurance that additional financing, ifrequired, will be available on terms satisfactory to us or at all, and if fundsare raised in the future through issuance of preferred stock or debt, thesesecurities could have rights, privileges or preference senior to those of ourcommon stock and newly issued debt could contain debt covenants that imposerestrictions on our operations. Further, any sale of newly issued debt orequity securities could result in additional dilution to our currentshareholders.

 

***Income taxes***

 

TheChina Corporate Income Tax Law (“CIT Law”) became effective on January 1,2008. Under the CIT Law, China’s dual tax system for domestic enterprises andforeign investment enterprises (“FIEs”) was effectively replaced by a unifiedsystem. The new law establishes a tax rate of 25% for most enterprises and areduced tax rate of 15% for certain qualified high technology enterprises.

 

Priorto this change in tax law, certain subsidiaries and joint ventures located inChina enjoyed tax benefits in China which were generally available to FIEs. Thetax holidays/incentives for FIEs were applicable or potentially applicable toUTStarcom Chongqing Telecom Co. Ltd. (“CUTS”), UTStarcomTelecom Co., Ltd. (“HUTS”) and UTStarcom China Co., Ltd. (“UTSC”),our active subsidiaries in China, as those entities may qualify as accreditedtechnologically advanced enterprises.

 

TheCIT Law targets certain industries for the reduced 15% tax rate for certainqualified high technology enterprises. For FIEs established before thepromulgation of the new law who had previously enjoyed lower tax rates, anyincrease in their tax rates would be gradually phased in over five years.During the fourth quarter of 2008, two of our China subsidiaries, HUTS andUTSC, were approved for the reduced 15% tax rate. The approval lasts for threeyears and is retroactive to January 1, 2008.

 

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TheChinese central government may review and audit tax benefits granted by localor provincial authorities and could determine to disallow such benefits.Certain of our subsidiaries and joint ventures located in China enjoy taxbenefits in China that are generally available to foreign investmententerprises. If these tax benefits are reduced, disallowed or repealed due tochanges in tax laws or determination by the Chinese government, our businesscould suffer.

 

***Off-balance sheet arrangements***

 

AtSeptember 30, 2010, we do not have any off-balance sheet arrangements.

 

***Contractual obligations and other commitments***

 

Ourobligations under contractual obligations and commercial commitments atSeptember 30, 2010 were as follows:

 
| ** **           | ** ** | **Payments Due by Period** | ** ** |
|----------------------|------------|-------------------------------------------|------------|
| ** **           | ** ** | ** **                                | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| ** **           | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **5 years** | ** ** |
| ** **           | ** ** | ** **                                | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                 |       |                                      |       |   |   |   |   |   |   |   |   |
| Operating leases     |       | $                                         | 77,614     |   | $ | 16,105 |   | $ | 29,130 |   | $ | 28,627 |   | $ | 3,752 |   |
| Letters of credit    |       | 23,342                                    |       | 16,248 |   | 7,008 |   | 86 |   |   |   |
| Purchase commitments |       | 39,347                                    |       | 35,448 |   | 3,899 |   | — |   | — |   |
| Total                |       | $                                         | 140,303    |   | $ | 67,801 |   | $ | 40,037 |   | $ | 28,713 |   | $ | 3,752 |   |

 

*Operating leases*

 

Welease certain facilities under non-cancelable operating leases that expire atvarious dates through “2013” to “2016”. In connection with the Sale LeasebackAgreement, on February 1, 2010, we entered into a Lease Contract (the “Lease”)with respect to the leaseback of a portion of the Hangzhou facility. The Leasebecame effective on June 1, 2010 and the contractual obligations relatedto the Hangzhou facility Lease are included in the table above.

 

*Letters of credit*

 

Weissue standby letters of credit primarily to support international salesactivities outside of China and in support of purchase commitments. When wesubmit a bid for a sale, often the potential customer will require that weissue a bid bond or a standby letter of credit to demonstrate our commitmentthrough the bid process. In addition, we may be required to issue standbyletters of credit as guarantees for advance customer payments upon contractsigning or performance guarantees. The standby letters of credit usually expiresix to twelve months from date of issuance without being drawn by the beneficiarythereof.

 

*Purchase commitments*

 

Weare obligated to purchase raw materials and work-in-process inventory undervarious orders from various suppliers, all of which should be fulfilled withoutadverse consequences material to our operations or financial condition.Purchase commitments in the table above include agreements that are cancelablewithout penalty.

 

*Intellectual property*

 

Certainsales contracts include provisions under which customers would be indemnifiedby us in the event of, among other things, a third-party claim against thecustomer for intellectual property rights infringement related to our products.There are no limitations on the maximum potential future payments under theseguarantees. We have not accrued any amounts in relation to these provisions asno such claims have been made and we believe we have valid enforceable rightsto the intellectual property embedded in our products.

 

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*Uncertaintax positions*

 

Asof September 30, 2010, we had $92.9 million of gross unrecognized taxbenefits. If recognized, the portion of gross unrecognized tax benefits thatwould decrease the provision for income taxes and decrease our net loss is$78.5 million. The impact on net loss reflects the gross unrecognized taxbenefits net of certain deferred tax assets and the federal tax benefit ofstate income tax items totaling $14.4 million. We have not included theseamounts in the table of contractual obligations and commercial commitmentsbecause of the difficulty in making reasonably reliable estimates of the timingof cash settlements with the respective taxing authorities.

 

*Third Party Commissions*

 

Werecord accruals for commissions payable to third parties in the normal courseof business. Such commissions are recorded based on the terms of the contractsbetween the Company and the third parties and paid pursuant to such contracts.Consistent with our accounting policies, these commissions are recorded as costof net sales in the period in which the liability is incurred. As of September 30,2010, we had approximately $0.5 million of such accrued commissions. Managementhas performed, and continues to perform, follow-up procedures with respect tothese accrued commissions. Upon completion of such follow-up procedures, if theaccrued commissions have not been claimed and the statute of limitations, ifany, has expired, we will reverse such accruals. Such reversals are recorded inthe Statement of Operations during the period management determines thatsuch accruals are no longer necessary. With the assistance of our Chinacounsel, we concluded that for certain of these accrued commissions the statuteof limitations had expired in August 2010, two years after formal communicationwas sent to these agents. During the three and nine months ended September 30,2010 approximately $5.8 million and $6.0 million respectively were released tocost of net sales as a result of expiration of statute of limitations. Nosignificant reversals of accruals for third party commissions are expected in2011. During the three and nine months ended September 30, 2009, wereleased approximately $0.7 million and $0.8 million of accruals related tothird party commissions respectively to cost of net sales as a result ofexpiration of statute of limitations.

 

*India Department of Telecommunication Security andSupply Chain Standards*

 

Recentchanges in India require equipment manufacturers to satisfy certain securityand supply chain standards to the satisfaction of Indian authorities.Management entered into such agreements with several customers in India whichestablish detailed security and supply chain standards covering productssupplied to telecommunication customers. These agreements contain significant penalty clauses in the event asecurity breach is detected related to product supplied by the Company.  Management is unable to estimate thelikelihood or the financial impact of any such potential securitybreach on our financial position, results of operations, or cash flows.The Company is currently assessing the potential impact these agreements mayhave on the timing of revenue recognition.

 

**ITEM 3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Weare exposed to the impact of interest rate changes, changes in foreign currencyexchange rates and changes in the stock market.

 

***Interest Rate Risk***

 

Our exposure to market risk for changes in interest rates relatesprimarily to our investment portfolio. The fair value of our investmentportfolio would not be significantly affected by either a 10% increase ordecrease in interest rates due mainly to the short term nature of most of ourinvestment portfolio. However, our interest income can be sensitive to changesin the general level of U.S and China interest rates since the majority of ourfunds are invested in instruments with maturities of less than one year. In adeclining interest rate environment, as short term investments mature,reinvestment occurs at less favorable market rates. Given the short term natureof certain investments, anticipated declining interest rates will negativelyimpact our investment income.

 

We maintain an investment portfolio of various holdings, types andmaturities. We do not use derivative financial instruments. We place our cashinvestments in instruments that meet high credit quality standards, as specifiedin our investment policy guidelines. Our policy is to limit the risk ofprincipal loss and to ensure the safety of invested funds by generallyattempting to limit market risk. Funds in excess of current operatingrequirements are mostly invested in money market funds which are rated AAA. Ourcash and cash equivalents are not subject to significant interest rate risk dueto the short maturities of these instruments. As of September 30, 2010 thecarrying value of our cash and cash equivalents approximated fair value.

 

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The table below representscarrying amounts and related weighted-average interest rates of our investmentportfolio at September 30, 2010:

 
| ** **                   | ** ** | **(in thousands, except  interest rates)** | ** ** |
|------------------------------|------------|-----------------------------------------------------------|------------|
| Cash and cash equivalents    |       | $                                                         | 337,026    |   |
| Average interest rate        |       | 0.80                                                      | %          |
|                         |       |                                                      |       |
| Restricted cash - short-term |       | $                                                         | 22,444     |   |
| Average interest rate        |       | 0.01                                                      | %          |
|                         |       |                                                      |       |
| Short-term investments       |       | $                                                         | 972        |   |
| Average interest rate        |       | 0.00                                                      | %          |
|                         |       |                                                      |       |
| Restricted cash - long-term  |       | $                                                         | 7,586      |   |
| Average interest rate        |       | 0.01                                                      | %          |
|                         |       |                                                      |       |
| Total investment securities  |       | $                                                         | 368,028    |   |
| Average interest rate        |       | 0.73                                                      | %          |

 

***Investment Risk***

 

Wehave invested in several privately held companies as well as investment fundswhich invest primarily in privately held companies, many of which can still beconsidered in the start-up or development stages. These investments areinherently risky, as the market for the technologies or products they haveunder development are typically in the early stages and may never materialize.

 

***Foreign Exchange Rate Risk***

 

Asa multinational company, we conduct our business in a wide variety ofcurrencies and are therefore subject to market risk for changes in foreignexchange rates.  We expect to continue toexpand our business globally and, as such, expect that an increasing proportionof our business may be denominated in currencies other than U.S. Dollars.  As a result, fluctuations in foreigncurrencies may have a material impact on our business, results of operationsand financial condition.

 

Historically,the majority of our foreign-currency denominated sales have been made in China,denominated in Renminbi. Additionally, since 2006, we made significant sales inJapanese Yen, Euros, Indian Rupees and Canadian Dollars. Due to China’scurrency exchange control regulations, we are limited in our ability to convertand repatriate Renminbi, as well as in our ability to engage in foreigncurrency hedging activities in China. The balance of our cash held in China was$202.9 million at September 30, 2010. Since China un-pegged the Renminbi from the U.S. Dollar in July, 2005,through September 30, 2010, the Renminbi has strengthened by more than 15%versus the U.S. Dollar.  However, it isuncertain what further adjustments may be made in the future.

 

Wemay manage foreign currency exposures using forward and option contracts tohedge and thus minimize exposure to the risk of the eventual net cash inflowsand outflows resulting from foreign currency denominated transactions withcustomers, suppliers, and non-U.S. subsidiaries, however, we are not currentlyhedging any such transactions.  As ourforeign currency balances are not currently hedged, any significant revaluationof our foreign currency exposures may materially and adversely affect ourbusiness, results of operation and financial condition.  We do not enter into foreign exchange forwardor option contracts for trading purposes.

 

Givenour exposure to international markets, we regularly monitor all of our materialforeign currency exposures.  We usesensitivity analysis to measure our foreign currency risk by computing thepotential decrease in cash flows that may result from adverse or beneficialchanges in foreign exchange rates, relative to the functional currency with allother variables held constant.  Theanalysis covers all of our underlying exposures for foreign currencydenominated financial instruments.  Theforeign currency exchange rates used were based on market rates in effect atSeptember 30, 2010.  The sensitivityanalysis indicated that a hypothetical 10% adverse or beneficial movement inexchange rates would have resulted in a loss or gain in the fair values of ourforeign currency denominated financial instruments of $15.8 million atSeptember 30, 2010.

 

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**ITEM 4—CONTROLS AND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

The Companymaintains disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in the reports the Company files orsubmits pursuant to the Securities Exchange Act of 1934, as amended (“ExchangeAct”), is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s (“SEC”) rules andforms, and that such information is accumulated and communicated to the Company’smanagement, including its chief executive officer (“CEO”) and chief financialofficer (“CFO”), as appropriate, to allow timely decisions regarding requiredfinancial disclosure.

 

In connection withthe preparation of this Quarterly Report on Form 10-Q (“Form 10-Q”),the Company carried out an evaluation as of September 30, 2010 under thesupervision and with the participation of the Company’s management, includingthe CEO and CFO, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures, as such term is defined inRules 13a-15(e) and 15d-15(e) under the Exchange Act. Based uponthis evaluation, management concluded that as of September 30, 2010 theCompany’s disclosure controls and procedures were not effective because of thematerial weaknesses described in “Management’s Annual Report on InternalControl over Financial Reporting,” included in “Part II, Item 9A -Controls and Procedures” (“Item 9A”) in the Company’s Annual Report onForm 10-K for the fiscal year ended December 31, 2009 (the “2009Annual Report”), which have not yet been remediated. Investors are directed toItem 9A in the 2009 Annual Report for the description of these weaknesses.

 

A “materialweakness” is a deficiency, or a combination of deficiencies, in internalcontrol over financial reporting, such that there is a reasonable possibilitythat a material misstatement of the Company’s annual or interim financialstatements will not be prevented or detected on a timely basis. To address thematerial weaknesses in internal control over financial reporting noted above,the Company performed additional analyses and other procedures (as furtherdescribed below under “Management’s Planned Remediation Initiatives and InterimMeasures”) to ensure that the Company’s consolidated financial statements wereprepared in accordance with generally accepted accounting principles in theUnited States (“GAAP”). Accordingly, the Company’s management believes that theconsolidated financial statements included in this Form 10-Q fairlypresent in all material respects the Company’s financial condition, results ofoperations and cash flows for the periods presented and that thisForm 10-Q does not contain any untrue statement of a material fact or omitto state a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the periods covered by this report.

 

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**Management’sPlanned Remediation Initiatives and Interim Measures**

 

The Company plansto make necessary changes and improvements to the overall design of its controlenvironment to address the material weaknesses in internal control overfinancial reporting noted above. In particular, the Company implemented during2009 and the first three quarters of 2010, and plans to continue to implementduring the remainder of 2010, the specific measures described below. Inaddition, in connection with the September 30, 2010 quarter-end reportingprocess, the Company has undertaken additional measures described under thesubheading “Interim Measures” below to provide reasonable assurance regardingthe reliability of financial reporting and the preparation of the Company’sconsolidated financial statements included in this Form 10-Q and to ensurethat material information relating to the Company and its consolidatedsubsidiaries was made known to management in connection with the preparation ofthis Form 10-Q.

 

***Remediation Initiatives***

 

1. Toremediate the material weakness described in Item 9A in the 2009 Annual Reportover “*The recording of reserves for losseson customer contracts,*” the Company transitioned the responsibilityfor calculating the loss contract reserves to its local project office in Indiain the third and fourth quarters of 2008, which facilitated enhancedcoordination between the local business units, operations, sales and thefinance teams and resulted in more timely and complete information beingavailable for analysis by the finance department. During the third quarter of2009, the Company finalized its assessment of additional implemented modules ofits ERP system in the operation in India, which enhanced the overall monitoringand analysis of the various accounts and balances in India. Although we believethat these enhanced procedures improved the accuracy of the loss reservecalculation, they have not been operating for an adequate period of time toensure effective remediation as of September 30, 2010. In the remainder of2010, the Company will continue performing the current procedures and makefurther enhancements, if needed, to confirm full and effective remediation.

 

2. To remediatethe material weakness described in Item 9A in the 2009 Annual Report over “*Period-end financial reporting process*”the Company added technical resources to the finance team in China in the thirdand fourth quarters of 2009 as well as in the first three quarters of 2010. Inthe remainder of 2010, the Company will continue its effort to consolidate andstreamline its global close process in China, the additional technicalresources will enable the Company to broaden the scope and quality of the independentreviews of underlying information related to the Company’s period-end financialreporting process, to standardize the processes for such financial reviews andto ensure the reviewers analyze and monitor financial information in aconsistent and thorough manner.

 

3. Toremediate the material weakness described in Item 9A in the 2009 Annual Reportover “*internal control over financialreporting related to revenue recognition,*” the Company will continueto enhance its contracts review process in order to ensure that appropriatemembers of management have reviewed and confirmed critical informationnecessary to assess the proper revenue recognition accounting. The Company willcontinue to assess and enhance its technical resources to broaden the scope andquality of the independent reviews of underlying information related to therevenue contracts.

 

**InterimMeasures**

 

Managementhas not yet implemented all of the measures described above under the heading “*Remediation Initiatives*” and/or testedthem. Nevertheless, management believes the measures identified above to theextent they have been implemented, together with other measures undertaken bythe Company in connection with the preparation of the condensed consolidatedfinancial statements included in this Form 10-Q and described below,address the material weaknesses in internal control over financial reportingdescribed above. These other measures include the following:

 

1.Extensive reviews of the reserves for losses on customer contracts including,in India, reviews of the inventory cost against the current cost backlog reportand reconciliation between the local cost records to the cost records at theCompany’s headquarters.

 

2. Avariety of manual review procedures, such as an extensive review of journalentry postings into the ERP system, a thorough review of accountreconciliations, including revenue and deferred revenue accounts, and adetailed review at its headquarters of trial balances including those issuedfrom decentralized locations, to ensure the completeness and accuracy of theunderlying financial information used to generate the consolidated financialstatements.

 

3. Variousreviews of the revenue contracts and associated accounting memos as well as theconsolidated revenue schedules and fulfillment status reports to ensure thatrevenue is accurately and completely recorded.

 

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***Management’s Conclusion***

 

Managementbelieves the remediation measures described under “Management’s PlannedRemediation Initiatives and Interim Measures” above will strengthen the Company’sinternal control over financial reporting and remediate the material weaknessesidentified above. However, management has not yet implemented all of thesemeasures and/or tested them. Management believes that the interim measuresdescribed under “Management’s Planned Remediation Initiatives and InterimMeasures” above ensure the reliability of financial reporting and thepreparation of the Company’s financial statements included in thisForm 10-Q and has discussed this with the Company’s Audit Committee.

 

The Company iscommitted to continue improving its internal control processes and willcontinue to diligently and vigorously review its disclosure controls andprocedures and its internal control over financial reporting in order to ensurecompliance with the requirements of Section 404 of the Sarbanes-Oxley Actof 2002. However, any control system, regardless of how well designed, operatedand evaluated, can provide only reasonable, not absolute, assurance that itsobjectives will be met. As management continues to evaluate and work to improvethe Company’s internal control over financial reporting, it may determine totake additional or alternate measures to address control deficiencies, and itmay determine not to complete certain of the measures described under “Management’sPlanned Remediation Initiatives and Interim Measures” above.

 

**Changesin Internal Control over Financial Reporting**

 

No changes otherthan those described above occurred during the three months ended September 30,2010 in our internal control over financial reporting that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART II—OTHERINFORMATION**

 

**ITEM 1—LEGAL PROCEEDINGS**

 

Fora description of litigation and governmental investigations, see Note 10 to ourCondensed Consolidated Financial Statements included under Part 1, Item1 of this Quarterly Report on Form 10-Q.

 

**ITEM 1A—RISK FACTORS**

 

For a description of risk factors that couldmaterially affect our business, financial condition and future operatingresults, please consider the risk factors set forth in “Part I, Item1A — Risk Factors” of our Annual Report on Form 10-K for thefiscal year ended December 31, 2009. Additional risks and uncertaintiesnot currently known to us or that we currently deem to be immaterial also maymaterially and adversely affect our business, financial condition or futureoperating results.

 

**ITEM 2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

Therewere no unregistered sales of equity securities during the period covered bythis report other than those discussed in our Form 8-K filed on September 13,2010.

 

**Issuer Purchases of Equity Securities**

 

**The following table summarizes the Company’s stock repurchase activityfor the three months ended September 30, 2010:**

 
| **Period**          | ** ** | **Total number of shares  Purchased (1)** | ** ** | **Average price  paid per share** | ** ** | **Total number of shares  purchased as  part of publicly announced  plans or programs** | ** ** | **Approximate dollar value  of shares that  may yet be purchased under  the plans or programs** | ** ** |
|---------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                |       |                                                          |       |                                             |       |                                                                                                                                 |       |                                                                                                                                                   |       |
| July 2010      |       | —                                                        |       | $                                                | —     |                                                                                                                                 | —     |                                                                                                                                                   | $          | — |   |
| August 2010    |       | —                                                        |       | $                                                | —     |                                                                                                                                 | —     |                                                                                                                                                   | $          | — |   |
| September 2010 |       | 10,860                                                        |       | $                                                | 2.00       |                                                                                                                                 | —     |                                                                                                                                                   | $          | — |   |
| Total               |       | 10,860                                                        |       |                                             |       | —                                                                                                                               |       | $                                                                                                                                                      | —     |   |

 

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(1)          During the third quarter of 2010, the Companyacquired 10,860 shares of common stock that employees presented to the Companyto satisfy withholding taxes in connection with the vesting of restricted stockawards.

 

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**ITEM 3—DEFAULTS UPON SENIOR SECURITIES**

 

None

 

**ITEM 4— REMOVED AND RESERVED**

 

**ITEM 5—OTHER INFORMATION**

 

The 2010 annual meeting of the stockholders of theCompany has been scheduled to be held at 20F, Tower E1, The Towers, OrientalPlaza, No. 1 East Chang An Ave., Dong Cheng District, Beijing, China, onMonday, December 13, 2010 at 1:00 p.m., local time.  For more information on our annual meeting ofthe stockholders and proxy statement, see our Proxy Statement filed on October 27,2010.

 

**ITEM 6—EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                   | ** ** | **Form** | ** ** | **Incorporated  by Reference  From Exhibit  Number** | ** ** | **Date Filed** | ** ** |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------------------------------------------------------------|------------|---------------------|------------|
|                |       |                                                                                                                                                                              |       |     |       |                                                           |       |                |       |
| 3.1                 |       | Thirteenth  Amended and Restated Certificate of Incorporation of UTStarcom, Inc., as  amended.                                                                               |       | 8-K      |       | 3.1                                                            |       | 12/12/2003          |       |
|                |       |                                                                                                                                                                              |       |     |       |                                                           |       |                |       |
| 3.2                 |       | Second  Amended and Restated Bylaws of UTStarcom, Inc., as effective  June 28, 2008.                                                                                    |       | 8-K      |       | 3.1                                                            |       | 4/14/2008           |       |
|                |       |                                                                                                                                                                              |       |     |       |                                                           |       |                |       |
| 4.1                 |       | See  exhibits 3.1 and 3.2 for provisions of the Certificate of Incorporation  and Bylaws defining the rights of holders of Common Stock.                                     |       | —   |       | —                                                         |       | —              |       |
|                |       |                                                                                                                                                                              |       |     |       |                                                           |       |                |       |
| 4.2                 |       | Specimen  Common Stock Certificate.                                                                                                                                               |       | S-1/A    |       | 4.1                                                            |       | 2/7/2000            |       |
|                |       |                                                                                                                                                                              |       |     |       |                                                           |       |                |       |
| 4.3                 |       | Third  Amended and Restated Registration Rights Agreement dated December 14,  1999.                                                                                          |       | S-1      |       | 4.2                                                            |       | 12/20/1999          |       |
|                |       |                                                                                                                                                                              |       |     |       |                                                           |       |                |       |
| 4.4                 |       | Stockholder  Rights Agreement, made as of February 1, 2010, by and between  UTStarcom, Inc. and Beijing E-town International Investment and  Development Co., Ltd. |       | 8-K      |       | 4.1                                                            |       | 2/4/2010            |       |
|                |       |                                                                                                                                                                              |       |     |       |                                                           |       |                |       |
| 4.5                 |       | Stockholder  Rights Agreement, made as of February 1, 2010, by and among  UTStarcom, Inc., Elite Noble Limited and Shah Capital Opportunity  Fund LP.              |       | 8-K      |       | 4.2                                                            |       | 2/4/2010            |       |

 

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| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                | ** ** | **Form**       | ** ** | **Incorporated  by Reference  From Exhibit  Number** | ** ** | **Date Filed** | ** ** |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------|------------|----------------------------------------------------------------|------------|---------------------|------------|
|                |       |                                                                                                                                                                                                                                                                           |       |           |       |                                                           |       |                |       |
| 10.1                |       | Third  Amendment to Common Stock Purchase Agreement dated February 1, 2010, as  amended on April 30, 2010 and June 4, 2010, by and between the  Company and Beijing E-town International Investment and Development Co., Ltd.                              |       | 8-K            |       | 10.1                                                           |       | 7/13/2010

    |       |
|                |       |                                                                                                                                                                                                                                                                           |       |           |       |                                                           |       |                |       |
| 10.2                |       | Third  Amendment to Common Stock Purchase Agreement dated February 1, 2010, as  amended on April 30, 2010 and June 4, 2010, by and among the  Company, Elite Noble Limited and Shah Capital Opportunity Fund LP.

                                         |       | 8-K            |       | 10.2                                                           |       | 7/13/2010           |       |
| 10.3                |       | Fourth  Amendment to Common Stock Purchase Agreement dated February 1, 2010, as  amended on April 30, 2010, June 4, 2010 and July 7, 2010, by  and between the Company and Beijing E-town International Investment and  Development Co., Ltd.

  |       | 8-K            |       | 10.1                                                           |       | 9/13/2010           |       |
| 10.4                |       | Fourth  Amendment to Common Stock Purchase Agreement dated February 1, 2010, as  amended on April 30, 2010, June 4, 2010 and July 7, 2010, by  and between the Company and Elite Noble Limited and Shah Capital Opportunity  Fund LP.                      |       | 8-K            |       | 10.2                                                           |       | 9/13/2010           |       |
|                |       |                                                                                                                                                                                                                                                                           |       |           |       |                                                           |       |                |       |
| 31.1                |       | Certification  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                     |       | Filed herewith |       | —                                                         |       | —              |       |
|                |       |                                                                                                                                                                                                                                                                           |       |           |       |                                                           |       |                |       |
| 31.2                |       | Certification  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                     |       | Filed herewith |       | —                                                         |       | —              |       |
|                |       |                                                                                                                                                                                                                                                                           |       |           |       |                                                           |       |                |       |
| 32.1                |       | Certifications  Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                           |       | Filed herewith |       | —                                                         |       | —              |       |

 

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*              Management contract, plan orarrangement

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                    |     | UTSTARCOM, INC. |
|-------------------------|----------|----------------------|
|                    |     |                 |   |
| Date:  November 8, 2010 |     | By:                  | /s/  EDMOND CHENG |
|                    |     |                 | Edmond  Cheng |
| * *                | * * | * *             | *Senior Vice President and Chief Financial Officer* |
| * *                | * * | * *             | *(Principal  Financial Officer)* |

 

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